Book-review: The little book that still beats the market, Greenblatt

There might be a magic formula.

If you prefer to read the pdf version click here. (links may not work in pdf)

(as in my previous book review I focus more on my learnings/insights/personal summary vs writing style etc.)

The foreword and the introduction to the 2010 edition were funny to read and short (it’s a little book) and I actually read them.

Expected returns above safe bonds are the only way to entice our interest in investments. Or it should be that way.

Shares entitle us to a share of an earnings stream of the business. Past, current or next years earnings can be a first indication, but we have to think about future trends and the uncertainty thereof.

Trading ranges of stocks are pretty wild. Tables with 52w high and low stock prices show this. This indicates it is often possible to buy with a large margin of Safety.

Buying good businesses at bargain prices. That means earning a high earnings yield relative to safe bonds on our purchase price for a business that earns good returns on capital.

The magic formula combines a company’s rank of earnings yield (cheapness) and return on capital (business quality). Companies with the lowest combined ranks are usually a good buy for high investment returns.
• Results are robust for different company sizes (their market capitalizations).
• A sub-group of companies with better ranks performs better than the next best group.
• The strategy sometimes underperforms for 1, 2, or 3 years, and this might well be the reason for practicioners to give up and why the strategy ultimately works over the long-term.

Competition will erode some companies’ high returns on capital, but the magic formula works on average.

Greenblatt loves sailing but is not good at it … That could be me (I was recently sitting on a sandbank for several hours until we were rescued and our boat towed 😊. For many people or is quite the same with investing, we are not good at it or at least we do not know it for sure but we enjoy sth about it, ie process, or excitement. Using the magic formula may take away the fun.
• Most people have no business investing in / picking single stocks
• The formula uses trailing earnings and obviously forward earnings or normalized numbers would be better, but they are hard to come by, and on average trailing EPS are a good guess for future EPS.
• If picking stocks is our game, starting with the formula makes sense.

Stockbrokers are not to be trusted to make you money. Incentives matter.

Step by step instructions include some advise for minimizing us capital taxes. The portfolio of 20-30 stocks shall be built over a one year period. And stocks being sold after one year.

The most important thing if one pursues this strategy seems to believe in long term performance and follow through.
The best thing was to read, in another much bigger book which I do read in parallel but not on train rides: there is no magic formula. Like written above, this might actually be the reason why it works. On average!


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