Is your Magic Formula calculation true to Joel Greenblatt's book?

You can look up any UK company's Magic Formula score on its StockReport or here. We're pretty meticulous about using the EXACT definition used by Greenblatt, to the extent that it is clearly articulated in the book. We discuss how we do this in depth in this detailed article but, in summary, the steps are:

  1. Calculate Earnings Yield = EBIT / enterprise value.
  2. Calculate Return on Capital = EBIT / (Net fixed assets + working capital)
  3. EY Rank: Rank the stocks in descending order based on Earnings Yield and assign a rank number to each.
  4. ROC Rank: Rank the same stocks in descending order based on Return on Capital and assign a rank number to each.
  5. Add the rankings and select stocks that have the lowest combined ranking score.

We are aware that some sites use more of an approximation to the Magic Formula by using, for example, ROA rather Greenblatt's specific ROC definition.

You can see some interesting discussion on the Magic Formula here by Richard Beddard, chief blogger at Interactive Investor and a columnist for Money Observer:

  1. http://www.iii.co.uk/news-opinion/richard-beddard/formula-not-so-magic-uk/ (he critiques some other approaches here)
  2. http://www.moneyobserver.com/issue/features/nifty-thrifty-portfolio-gets-annual-overhaul (he discusses our approach).

We welcome all critiques over methodology, so let us know if you disagree with any of it via the Green Support Messenger.