The Magic Formula, developed by Joel Greenblatt, is a simple yet effective stock selection system that identifies undervalued companies with strong earnings yields and high returns on capital. Despite its name, there's nothing magical about it—it's a disciplined, quantitative approach to finding quality companies at reasonable prices.
Greenblatt's research showed that stocks scoring well on these two metrics (earnings yield and return on capital) significantly outperformed the market over long periods. The system is designed to find companies that are both cheap and good.
EBIT (Earnings Before Interest and Taxes) divided by enterprise value. Higher earnings yield means the company generates more earnings relative to its market price.
EBIT divided by invested capital. Higher ROIC means the company efficiently deploys capital to generate returns.
The Magic Formula uses a percentile-based ranking system. Each stock is ranked from 1-100 on both earnings yield and return on capital. The final Magic Formula score is the average of these two rankings.
Stocks with higher earnings yield get higher rankings (1-100).
Stocks with higher ROIC get higher rankings (1-100).
Average the two rankings to get the Magic Formula score. Lower scores are better.
Greenblatt's research showed that the Magic Formula has beaten the S&P 500 by 3-4% annually over long periods. The system works by finding companies that are both cheap (high earnings yield) and good (high ROIC).
The beauty of the Magic Formula is its simplicity and consistency. It doesn't require complex analysis or market timing—just disciplined stock selection based on two fundamental metrics.
Type the ticker symbol of any US stock you want to analyze.
The scanner calculates earnings yield and return on capital rankings.
Lower scores are better. Scores below 50 are generally attractive.
See how the stock ranks compared to its industry peers.
Use the suggested entry price and stop loss for position sizing.
Look for stocks that are both undervalued (high earnings yield) and have strong fundamentals (high ROIC).
The Magic Formula proves that simple, quantitative approaches often beat complex analysis.
Stick to the system. Don't try to pick winners or time the market.
The Magic Formula works best over 3-5 year periods. Be patient with your investments.