Finance
by Joel Greenblatt
Can a simple rule beat the market?
Most professional fund managers fail to beat the stock market. Joel Greenblatt, who runs a hedge fund and teaches at Columbia Business School, wrote this book for his own children. It sets out a two-part rule for picking shares, and his tests show it beating the market over long stretches.
Hear a sample · read by Laura
Greenblatt measures cheapness with earnings yield. Take a company's operating profit and divide it by what it would cost to buy the whole thing, meaning its shares plus its net debt. The higher the yield, the more the business earns for every dollar you pay.
For quality he uses return on capital. That's operating profit divided by the money tied up in running the business, its working capital plus its shops, factories and equipment. A company that earns a lot on very little capital is usually a very good business.
Rank companies by earnings yield, rank them again by return on capital, and add the two ranks. The best combined scores are good businesses at bargain prices. Greenblatt leaves out utilities and financial companies such as banks and insurers, because their accounts don't suit the measures.
The formula can trail the market for months, sometimes for two or three years in a row. Greenblatt says that's why it still works. Most people give up on a method that looks wrong for that long, which leaves the bargains to the few who stay.
Good and cheap
Buy good companies when they're on sale. That's the whole idea.
Return on capital
A good company earns a lot on the money it puts into the business.
Earnings yield
A cheap company earns a lot compared with what you'd pay for all of it.
The formula
Rank companies on both measures and buy the ones that score best together.
Sticking with it
The formula can trail the market for years at a time. That's exactly when most people quit.
A story from the book
Greenblatt starts with Jason, a sixth-grader who buys packs of gum and sells single pieces to his classmates at a mark-up. Would you buy a share of Jason's business? That depends on how much it earns, and on what you're asked to pay for it.
One thing to try
Pick a company you know. Find its operating profit in the latest annual report. Add the market value of its shares to its debt and subtract its cash. Divide the profit by that total, then do the same for a rival and see which gives more for the money.
Knotd has the key ideas from 250+ non-fiction books, each in a few minutes, in plain words. The Little Book That Still Beats the Market comes with a Your Move story to make it stick.
Get the whole book on KnotdOpen in the appCan a simple rule beat the market? Most professional fund managers fail to beat the stock market. Joel Greenblatt, who runs a hedge fund and teaches at Columbia Business School, wrote this book for his own children. It sets out a two-part rule for picking shares, and his tests show it beating the market over long stretches.
How cheap is it?; How good is it?; The magic formula; Why it keeps working.
Pick a company you know. Find its operating profit in the latest annual report. Add the market value of its shares to its debt and subtract its cash. Divide the profit by that total, then do the same for a rival and see which gives more for the money.
Yes. Knotd has the key ideas from The Little Book That Still Beats the Market in a few minutes, in plain words, plus a Your Move story to test them. It's one of 250+ non-fiction books in the app.
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