Joel Greenblatt: The Magic Formula That Beat the Market
Joel Greenblatt reportedly earned roughly 40% a year, then shared his Magic Formula. How he blends quality and value — and why it is so hard to follow.
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- Joel Greenblatt reportedly earned roughly 40% a year at Gotham Capital for about two decades
- His "Magic Formula" ranks stocks on just two factors: cheapness and quality
- The idea is to buy good companies at bargain prices — Buffett's insight, made systematic
- He completes MainRatios' set of six legendary investors alongside Buffett and Graham
- The catch: the strategy only works if you stick with it through long stretches of pain
From 1985 to 2005, Joel Greenblatt's Gotham Capital reportedly compounded at roughly 40% a year — one of the most remarkable long-run performances in modern investing. Then he did something almost no great investor does: he gave the formula away in a book simple enough for a teenager to read.
The Origin Story: From Gotham to the Classroom
Joel Greenblatt founded Gotham Capital in 1985 with a simple obsession — finding mispriced securities the rest of Wall Street overlooked. His early edge came from special situations: spinoffs, restructurings, and merger securities that big funds ignored because they were too small or too messy.
The results were extraordinary. Over roughly two decades, Gotham reportedly compounded at about 40% a year before Greenblatt returned outside investors' capital in the mid-1990s to run a leaner book. As always with such figures, past performance is no guarantee of future results — but the run drew a crowd of imitators.
What sets Greenblatt apart is not just the returns — it is that he tried to reduce his entire edge to a formula anyone could follow. He later taught value investing at Columbia Business School and co-founded the Value Investors Club, an online community for serious stock pickers.
What Is Greenblatt's Investing Philosophy?
Buy good businesses at bargain prices. That is the entire thing, and its power is in the combination — Graham's discipline of paying less than something is worth, fused with Buffett's insistence on business quality.
Most investors pick one side. Deep-value buyers chase cheap stocks that are often cheap for a reason; quality buyers chase great companies and overpay. Greenblatt's insight was that you can screen for both at once and let the math, not your emotions, do the choosing.
He treats the market as a manic partner — Graham's "Mr. Market" — who quotes you silly prices, and your only job is to exploit his mood swings. For the foundations of this style, see our fundamental analysis guide.
The Five Principles Behind the Magic Formula
Greenblatt's approach boils down to five ideas any investor can borrow.
First, quality matters — favor companies that earn high returns on the capital they deploy. Second, price matters just as much — only buy them when the earnings yield is high, meaning the stock is cheap relative to profits.
Third, be systematic. A rules-based screen removes the emotion that wrecks most portfolios. Fourth, diversify across a basket, because any single cheap-and-good stock can still disappoint. Fifth, be patient — the edge shows up over years, not quarters.
The formula is not magic because it is complex; it is powerful precisely because it is simple and repeatable. These ideas echo across our super investors profiles.
How Does the Magic Formula Actually Work?
It ranks the entire market on two numbers and buys the best combined scores. The first factor is earnings yield — operating profit divided by enterprise value — which measures cheapness. The second is return on capital — operating profit against the capital the business uses — which measures quality.
The screen ranks every stock on each factor, adds the two ranks together, and you buy a basket of the top names, rebalancing about once a year. In his book, Greenblatt reported roughly 30% annualized backtested returns over about 17 years, though real-world results are typically lower once you subtract costs, taxes, and human behavior.
The formula deliberately buys stocks that look uncomfortable — cheap companies the market has soured on — which is exactly why so few investors can hold them. To see how this fits a broader plan, read our investment strategies guide.
Which Stocks Screen as Magic Formula Candidates?
The ones with two traits at once: a high return on capital and a low price relative to earnings. This table is illustrative of the profile the screen hunts for — good business, cheap price — not a snapshot of Greenblatt's actual holdings, which change constantly.
| Stock | Why it can screen well | Formula side |
|---|---|---|
| Apple (AAPL) | Very high returns on capital | Quality |
| Microsoft (MSFT) | Durable, cash-generative | Quality |
| Alphabet (GOOGL) | High ROC at a fair price | Both |
| Gilead Sciences (GILD) | Cheap earnings yield | Value |
| Pfizer (PFE) | Low multiple, strong cash | Value |
| HP (HPQ) | Very cheap, high ROC | Both |
| Chevron (CVX) | Cheap when oil is out of favor | Value |
| Walmart (WMT) | Consistent returns on capital | Quality |
Names like Meta Platforms (META), Apple (AAPL), and Alphabet (GOOGL) can drift in and out of such a screen as prices and profits shift. The point is the discipline, not any one ticker.
Greenblatt in His Own Words
His writing is famous for making hard ideas plain and funny. A few of his best-known lines capture the whole philosophy.
"Choosing individual stocks without any idea of what you are looking for is like running through a dynamite factory with a burning match. You may live, but you are still an idiot."
"The secret to investing is to figure out the value of something — and then pay a lot less."
"Buying good businesses at bargain prices," he wrote, "is the secret to making lots of money" — a sentence that fits on an index card and has outlasted a thousand complicated strategies.
What Can Everyday Investors Learn From Him?
Two factors beat a hundred opinions. You do not need a supercomputer or inside information — you need a clear definition of "good and cheap" and the stomach to act on it when a stock feels scary.
Build a checklist and stick to it. Greenblatt's gift to ordinary investors was proof that a simple, disciplined process can outperform gut instinct over time. Screen for quality and value, diversify, and rebalance on a schedule rather than a whim.
Above all, separate the decision from the emotion. The reason GILD or PFE might screen as a bargain is usually that the news is bad — and buying when the news is bad is the hardest, most valuable habit in investing.
The Risk: Why Most People Cannot Follow It
The formula's greatest weakness is human. It can underperform the market for years at a stretch, and most investors abandon it right before it works — selling at the bottom, exactly the wrong move.
Critics also note that a strategy printed in a bestselling book is no longer a secret, and widely known edges tend to shrink. Cheap stocks can also stay cheap: some "bargains" are value traps that deserve their low price. And backtests flatter reality, ignoring the taxes, trading costs, and panic that erode real returns.
None of this makes the idea wrong — it makes it hard, and hard is precisely why the edge survives. Discipline, not cleverness, is the scarce resource.
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Frequently Asked Questions
It is a rules-based strategy that ranks stocks on two factors — earnings yield (cheapness) and return on capital (quality) — and buys a diversified basket of the highest combined scores, rebalanced about once a year. Greenblatt introduced it in "The Little Book That Beats the Market."
