Joel Greenblatt Strategy: The Definitive Guide

Today, one can learn Joel Greenblatt’s Strategy which is a one year buy and hold strategy.

It’s called the Magic Formula that screen quality stocks at a good price.

It’s like combining Warren Buffet and Benjamin Graham into a single strategy.

Well, one can say that it is magic because it is so simple to use.

The strategy is very profitable and more investors use it in their decisions.

One can use this trading strategy for a one-year holding period. Well, it is a medium-term strategy.

Warren likes to buy stocks with value while Benjamin wants cheap stocks.

In Joel’s strategy, as a quantitative trader, he developed the magic formula to find good stocks to buy and sell.

One can use it to hedge the stock market by shorting the lowest and buying the highest rank stocks.

The formula suggests that the higher the rank the higher the potential gain, vice versa.

An investor can really benefit from this strategy because it is proven to work for several decades.

More will be discussed below so that one can understand how this strategy works.

What is Joel Greenblatt’s Strategy?

Joel’s strategy the Magic Formula looks for Quality Stocks at a discounted price. (Source)

In the source article, the study shows that the strategy is lagging for about 10 years.

It is understandable because the strategy uses Tangible Capital Employed to find Quality stocks. Companies are heading more to the digital space or asset-light.

For example, digital commerce and lending.

Well, the method is still profitable and reliable.

However, it is still recommended that one should invest in companies that use tangible assets to generate profits in case something bad happens.

Now, there are only two criteria with Joel Grenblatt Strategy.

  • Quality Stocks
  • Value

In the future, a stock screener will be provided on this website for our country.

Feel free to comeback anytime because the target will be this year.

Value of the stock

How does a trader value a stock? Well, if he searches the web, he will see that most suggested methods are based on PE ratio or Price Earnings. (Source)

However, people who have traded for a long time know that earnings compared to price has no edge when used alone.

Well, what is the best method?

Joel Greenblatt Formula

Joel Greenblatt formula includes the earnings yield for ranking the value of stocks. He use earnings yield which is shown below:

EBITDA/ENTERPRISE VALUE

He ranks the stocks based on cheapness and then finds the best quality stocks among the group.

The higher value the better for him.

It makes sense to use this formula because it can be used to find the real value of the company if it is acquired.

For more information, one can buy his book to learn everything about Joel’s magic formula.

To continue, how to get the data?

Well, a quant could go to investing.com to calculate EBITDA

Well, one can add Operating Income and Depreciation/Amortization to calculate EBITDA.

Next, getting the Enterprise Value is simple.

One can add market capitalization and liabilities of the company.

It is important to add liabilities to the Market Cap and deduct the available cash to get the Enterprise Value.

Read Also: Mohnish Pabrai Spawners: A look at Market Capitalization

If a trader can tabulate this data into a database, he can rank all the stocks in the market.

However, it takes a lot of time to do it because there are thousands of stocks out there.

One should use a stock screener to save some time.

In this post, there will be no tutorial about how to scrap data because it is not the objective of this post.

However, anyone can make their own programs to become a real quantitative trader.

Next, he must rank the stocks based on quality which is discussed below.

Quality of Stock

How does Joel find quality stock. Well, he use this formula to find it.

EBITDA/Tangible Capital Employed.

Joel’s second ranking factor is quality. However, he focuses only on real assets.

Banks are obviously excluded from his lists because he wants to be safe in case something happens to the stock.

How to calculate Tangible Capital Employed?

Well, it is easy.

One can add Receivables, Inventories and Property Plant and Equipments.

He can also get it from investing.com

For Quants, data is very important to them. It is the one thing they need to decide on the next trade.

Most of them use portfolio123 to do backtesting with fundamental data. It is a powerful tool for value investors.

In this website, Amibroker is recommended, but if anyone wants to use methods other than technical analysis, then he can also use portfolio123.

Ranking Factor

Both cheapness and quality has 50:50 weight.

Quality(50%)+value(50%)=Final ranking

Joel Greenblatt Strategy

Joel Greenblatt’s strategy comprises the top 30 lowest scores that will be bought and held for one year and then rebalanced. The lowest scores have the greatest opportunity for buying undervalued but high-earning stocks.