A Quick The Little Book That Beats the Market Book Summary: If you’re looking to read a fantastic yet small book on stock market investing, then you’ve found the right one. Yes, I’m talking about Joel’s Greenblatt book “The Little Book That Beats the Market”.
The little book that beats the market is a classic value investing book that was originally written in 2005. This book educates the concept of value investing and Joel Greenblatt’s famous magic formula investing strategy, which is simple, effective, and patiently practiced, then is guaranteed to make profits in long run. Let’s get to know more about the book, it’s author, and the concepts covered in this book.
About the Author ‘Joel Greenblatt’
“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.” ― Joel Greenblatt, The Little Book That Beats the Market
Joel Greenblatt is an American investor, hedge fund manager, and a writer. He started an investment company named ‘Gowtham capital’ in 1985. This firm has given an impressive 40% annualized return for a duration of 20 years from 1985 to 2006.
‘The little book that beats the market’ became an instant best-seller when first published in 2005 and over millions of copy of this book has been sold till now. Joel dedicated the book ‘The little book that beats the market’ to his children. The book is written in a simple story-telling format so that anyone can read and easily understand, without any previous finance or investing knowledge.
Personally. Joel Greenblatt is a long-term investor and generally holds the stocks for more than a year in his portfolio. He believes that the market can be erratic in short term, however, the long-term stock market is quite efficient. In addition, Joel has also created a website based on his book and magic formula investing strategy which you can visit here.
The Little Book That Beats the Market Book Summary
Later, the concept of value investing i.e. buying stocks at a discounted price which is way below its true value is introduced. He describes it as “Paying a bargain price when you purchase a share ina business is a good thing. One way to do this is to purchase a business that earns more relative to the price you are paying rather than less.” Joel also talks about the importance of the Margin of Safety while investing in stock in these chapters.
Once the importance of value investing is covered, Joel teaches about his investing strategies, along with his popular investing approach of “Magic Formula”.
Magic Formula Investing Strategy
The book focuses on a magic formula that is based on two financial ratios- Return on capital and Earnings Yield.
1. Return on capital
ROC = EBIT/ (Net working capital + Net fixed capital).
Here, ROC is the ratio of the pre-tax operating earnings (EBIT) to tangible capital employed (Net working capital + Net fixed capital).
Joel Greenblatt has described why he used ROC in place of the commonly used financial ratios like ROE (Return on equity) or ROA (Return on assets). This is because, first of all, EBIT avoids the distortions arising from the differences in tax rates for different companies while comparing. Second, net working capital plus net fixed capital is used in place of fixed assets as it actually tells how much capital is needed to conduct the working of the company’s business.
Return on capital tells how efficient the company is in turning your investments into profits.
2. Earnings yield
Earning yield = EBIT / Enterprise value
Here, enterprise value is the market value of equity (including preferred shares) + net interest – bearing debt.
Earning yield how much money you can expect to make per year for each rupee you invest in the share.
Overall, ROC tells how good is the company, and Earning yield tell how good is the price.
Next, here are the three steps suggested by the author Joel Greenblatt in his book ‘the little book that beats the market’ to find companies for investment:
- Find the earning yields and return on capitals of the stock to evaluate stocks.
- Rank the companies according to the above two factors and combine them to find the best companies for investment.
- Have patience and remain invested for the long term. Lack of patience is why people fail to implement the magic formula.
How to use magic formula?
- Find the Return on capital (ROC) and Earning yield (EY) for all the companies.
- Sort all the companies by ROC rank.
- Sort all the companies by EY rank.
- Invest in the top 30 companies based on the combined factors.
|Company Symbol||ROC Rank||EY Rank||Combined Rank|
Now, we try to find the companies with the lowest combined factor rank.
For example, for company A, although it ranks 1 for the Return on capital. However, its earning yield rank is quite low and that’s why it’s combined rank is quite high. On the other hand, for company E, both ROC and EY rank are decent and hence its combined rank is good for investment.
Joel Greenblatt has already researched the top stock picks using this magic formula and found consistent good returns over the long term.
The little book that beats the market is a nice read and an excellent place to start reading if you have never invested in stocks before. The book is written in a very simple language and the concepts described in the book are time-tested.
You might think that why should I read the book when I have already given you the magic formula. This is because I have just explained a single chapter from the book. Think about how much knowledge you can gain by reading the entire book. Moreover, as the name of the book suggests, it’s a very little book with just 179 pages. You can easily read the book over a weekend and strengthen your financial concepts.
I highly recommend you read this book, especially if you are a beginner. You can buy the book from Amazon. Here’s the link.
That’s all. I hope that this post on ‘The Little Book That Beats the Market Book Summary’ is useful to the readers. Do comment below which is the best share market book that you have ever read.
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