Magic Formula Investing

Parent Strategy

Magic formula investing is a back-tested strategy that tells you how to approach value investing from a methodical perspective. It counts on quantitative screens of companies and stocks. Proven to have generated an average annual return of 30%, this strategy helps increase your chances of outperforming the market.

How to Put Magic Formula Investing to Work

  1. Set a minimum market capitalization for your portfolio companies (typically higher than $100 million).
  2. Exclude any financial or utility stocks.
  3. Exclude American depository receipts, which are stocks in foreign companies.
  4. Calculate each company's earnings yield (EBIT/Enterprise value).
  5. Calculate each company's return on capital [EBIT/(net fixed assets + working capital)].
  6. Rank selected companies by highest earnings yields and highest return on capital.
  7. Buy two to three positions each month in the top 20 to 30 companies, over the course of a year.
  8. Each year, rebalance the portfolio by selling off losers one week before the year-term ends and selling off winners one week after the year mark.
  9. Repeat the process each year for a minimum of five to 10 years or more.