What is Joel Greenblatt's Magic Formula?

The Magic Formula ranks every stock by two metrics: earnings yield (EBIT/EV - how cheap) and return on capital (ROIC - how profitable). Buy the top 20–30 stocks scoring highest on both combined, hold 1 year, repeat. Greenblatt published the formula in The Little Book That Beats the Market (2005). It has beaten the S&P 500 by approximately 6% annualized since 1988.

What are the two metrics in the Magic Formula?

Earnings Yield = EBIT / Enterprise Value (how cheap the business is relative to operating earnings - target above 10%). Return on Capital = EBIT / (Net Working Capital + Net Fixed Assets) - target above 25%. Rank every stock by each, sum the ranks, buy the lowest combined ranks. Both metrics use operating earnings to exclude financial-engineering noise.

What stocks does the Magic Formula avoid?

Greenblatt's screens exclude financials (banks/insurance - their balance sheets are leverage, not capital), utilities (regulated returns make ROIC meaningless), and stocks with one-time accounting gains. He also recommends using 5-year average earnings where possible to avoid cyclical peaks. Roughly 30% of the S&P 500 is excluded by these filters.

Does the Magic Formula still work in 2026?

Empirical backtests still show outperformance, but with two caveats: (1) The formula has had multi-year stretches of underperformance (notably 2017–2020 when growth dominated). (2) Modern market microstructure (passive flows, factor crowding) may erode the edge faster than in Greenblatt's original 1988–2004 sample. Best used as one input, not the only input.

Magic Formula - high ROIC + cheap EV/EBIT

Joel Greenblatt's Investing Strategy

Joel Greenblatt's Magic Formula is the simplest of the four - only two metrics - but it's beaten the S&P 500 by ~6% annually since 1988. The bet: high-quality businesses at cheap prices, ranked together.

Last reviewed: January 1, 2026

The framework, in plain English

Earnings yield (EBIT/EV) ≥ 10% - the company is cheap relative to its operating earnings.
Return on capital (ROIC) ≥ 25% - the company turns each dollar of capital into 25¢+ of operating profit.
Buy a basket of 20–30 stocks that score highest combined on both, hold 1 year, repeat.
Avoid: financials, utilities, and stocks with one-time accounting gains (use 5y averages where available).

From The Little Book That Beats The Market (Greenblatt, 2005).