Kapil Lehar

Book Review: The little book that beats the market

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Author: Joel Greenblatt

Genre: Equity Investment

Details:

Joel Greenblatt is an American academic, hedge fund manager, investor, and writer best known for this book whose review you are reading which even earned him a New York Times Bestseller.

Investing is hard. That’s why having a disciplined methodical, long term investment strategy that makes sense is essential to making it though and being successful in almost any market environment

He has a similar approach to that of Graham where one must buy shares only when they trade at a large discount to true value. This principle is what Margin of Safety is all about.

The author believes that predicting the future of a stock is a hard thing to do. When we look at things like quality of company’s products, the loyalty of customers, the value f its brands, the efficiency of its operations, the talent of its management, the strength of its competitors, or the long-term prospects of its business.

It turns out that if you stick to buying companies that have a high return on capital and to buy those companies only at bargain prices, you can end up systematically buying many of the good companies that crazy Mr. Market has literally decided to give away. And that itself is the magic formula or the holy grail. Throughout the chapters that follow the magic formula, Joel will try to convince you with ample of research how the magic formula has worked and gave him mammoth returns.

  Magic Formula S&P 500
1998 29.40% 16.60%
1989 30 31.7
1990 -6 -3.1
1991 51.5 30.5
1992 16.4 7.6
1993 0.5 10.1
1994 15.3 12
1995 55.9 37.6
1996 37.4 23
1997 41 33.4
1998 32.6 28.6
1999 14.4 21
2000 12.8 -9.1
2001 38.2 -11.9
2002 -25.3 -22.1
2003 50.5 28.7

But there is a caveat and that is: the returns take time to realize. In fact, on average, in five months out of each year, the magic formula portfolio does worse than the overall market. The magic formula portfolio even faired poorly relative to the market average in 5 out of 12 months tested and the formula failed to beat the market once every four years. That’s why patience is the most important thing that would take for the realization of this portfolio. It only works well over a long term.

Apart from holding the formula portfolio with patience, there are other notions that the investor must follow step by step to make the formula work. This can be done using a screener as well. The steps are mentioned in the last chapter, but It won’t make sense if you skip to the last chapter directly. Let the author convince you that the formula works, take time to be satisfied with the notions, make your own changes or filter out stocks that you don’t understand and then invest with confidence all the capital that you can live without for 5 years.

Although the author is affirmative about picking up 30 most prominent stocks based on the formula, If I were to use this approach, I would not add more than 10 stocks and would do some research on the company before investing. You are free to add your own filter criteria. The author has given you a foundation or base using which you can make your own approach or use the plain vanilla flavor of the formula.

Pre-requisites before reading the book: None

Is the content relevant even today? Yes

Vocabulary and Understandability: Easy

Level of investment expertise required: Any

How can it benefit you?

This book can help you understand the magic formula and how it is the simplest yet powerful approach to value investing. The longer you will hold the portfolio the more you would profit and earn handsome returns. As the new edition of the book rightly says, the little book STILL beats the market.

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