There Is No Consistent Magic Formula

As someone who bases his own approach on stock screening, I'm often asked about Joel Greenblatt's Magic Formula. So what's my view? Much like most stock screening strategies, each are prone to great winning AND losing streaks. This is something that Greenblatt himself recently admitted in an interview on CNBC:

"The magic formula works over the long haul precisely because it doesn't always work. The great thing about this formula is it's not that great that it works all the time, meaning there are periods of time - could be two or three years sometimes, sometimes longer - where it underperforms the market. And people usually give up on a formula that underperforms the market for that period of time.

Why is that a great thing? Well, if everybody stuck to the formula, the prices of those good companies the strategy identifies wouldn’t get to bargain levels. But since many bail on the strategy when it has an off year or two, disciplined investors are able to scoop up the bargains they’ve left behind. They can get stocks of those excellent companies at steep discounts by staying unemotional and disciplined, and sticking to their strategy. Those who don’t will often miss out on the bargains - and the excellent returns to which they often lead." - Joel Greenblatt

Like most strategies that are pinned to a specific strategy concentration (value, growth, momentum, etc.) they'll all experience their fair share of ups and downs. The problem is that most investors use these strategies only after a period of significant outperformance only to then suffer disappointing underperformance by doing so. That's also why my stock screen machine uses a blend of several different approaches to provide more consistent approach in different types of markets and why I think those who use stock screens should use several screening methods to generate actionable trading and research ideas.

Nevertheless, for more info on Joel Greenblatt's Magic Formula, here is Validea's own 10 stock portfolio based on Greenblatt's strategy. In addition, you can read more about and even access a free screener based on the Magic Formula at Greenblatt's website. In my experience, Greenblatt's screens (like many value-focused screens like our widest discounts to book value) tend to produce the best returns immediately following an extended market correction/bear market than following an extended and/or continued bull market. So keep that in mind when using this magic formula.