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The game grid, or American investor, became very well-known due to his famous magic formula for investing in stocks. This formula is described in the book "The Stock Market Within Your Reach." Greenwich's objective in writing this book was to pass on to his son the teachings and principles that enabled him to have so much success as an investor.
In this book, he shows in a very intuitive way how it is possible to have better performance than the market through a method he is known for. Curious to know how this formula works? Then watch this video until the end, and I'll show you how to use the gravity magic formula to build this Humblet investment method.
It starts from the premise that the market in general, in the short term, misjudges companies, causing many companies with good fundamentals to be sold at prices below their real value. Here, Greenwich resorts to another icon of the investment world, and they have already migrated to the market. He is not the creator of the famous parable of Mr.
Market, but according to Grit, the market knocks on your door every day with the price it deems most appropriate for your stocks. The problem is that many times he lets fear or fear take over. His thoughts invariably lead him to misprice the stocks traded on the market, causing some stocks to be overvalued or to rise in value.
In this case, it is up to the intelligent investor to identify the undervalued stocks and take advantage of these situations. To exemplify this, I would like you to see this graph with the price history of Bradesco stocks over a one-year period. Notice the large variation in the price of the stocks in a short period of time.
This is where Greenblatt's reasoning comes in. For him, there is very little time for these companies to change so much that their value changes so drastically in such a short time. Therefore, he said that the short-term market tends not to harm companies correctly, and thus can cause some stocks to rise in value.
The magic formula proposed by Greenblatt is nothing more than a method to find these rising stocks and profit from their appreciation. With the magic formula, a ranking is created where high-value companies are found. These high-value companies are found through return on capital. It is also necessary to find companies with low prices, and in turn, companies with low prices are found through the earnings-to-enterprise ratio.
The two indices used are the ROI (Return on Capital) and the ROI index. The ROI index is calculated by dividing EBITDA (Earnings Before Interest and Taxes) by net working capital plus net fixed assets. This index represents how much profit a company can generate in relation to the invested capital needed to run the business.
For example, suppose that creating a shoe factory requires R$500,000 and that in the first year of operation this company managed to generate R$100,000 in operating profit. Using the ROI calculation, we conclude that the return on capital of this factory is twenty percent. According to Greenblatt, this index shows us whether the company we are analyzing is a good or bad business.
But it's no use having a good business if we pay more than it's really worth. We must also know if the company is being sold at a price lower than its real value. To know this, we only need to calculate the return on capital. The ROI index is calculated by dividing the ROI by the company's value. The company's value in this case is the market value plus net debt.
Theoretically, this would determine if it is being sold at a low price or not. A ranking based on these two indices would select companies that have a good return on capital and are being sold at a low price. To create this ranking, simply list the companies according to their return on earnings, from highest to lowest, and also according to the MC Rock index, also from highest to lowest.
After that, you need to add up the positions each company holds in each of the indices. The companies that obtain the lowest resulting values from this sum are those that present the best quality-to-price ratios. For example, suppose a company is in first place in relation to Indie Rock and in 4th place in the return on earnings rate; the company's score would be five, since its first place in the MC Rock index and its fourth place in the Platinum return on earnings index were added together.
The companies with the lowest numbers resulting from the sum of the positions are the best companies to invest in. In addition, there are other Greenwich instructions for using the magic formula. The first instruction is that you should choose large companies; these companies should have at least a market capitalization greater than 50 million dollars.
The second instruction is that your portfolio should... The third instruction is that you should buy 5 to 7 shares of the highest- ranked companies in the formula, considering only 20 to 33 percent of the money you intend to invest throughout the year. The fourth instruction is that you should follow instruction three every two or three months until you have invested all your money.
After 9 to 10 months, this should result in a portfolio with approximately 20 to 30 shares. The Greenwich instruction is that you should sell each share held for one year. After that, the profits from any sale and any additional investment money should replace the number of shares sold with an equal number of shares in the new ranking.
The sixth step is that you have to maintain this process for several years. I know you must be wondering now, but does this method really work? Greenwich shows in the book that his method obtains results well above the market average, specifically the S&P 500. See the table with the results over a period from 1988 to 2004.
Greenblatt's method obtains a return of... 22.9 percent versus a return of 12.4 percent for the S&P 500 and 11.7 percent for the market average. Notice that the Greenwich formula significantly outperformed the S&P 500 index and the market average. But if the formula is so simple and yields such results, why don't you and Dori simply do it?
Grimbert argues that despite the formula's simplicity, the difficulty lies in sticking to the strategy over a long period. Periods of 1 to 3 years may arise where the formula simply yields a return below the market average, and it's very common for most investors to give up in these cases. But if you don't like basing your investments on any defined method, or you think a deeper analysis is needed to assess whether a company is good or not, perhaps it's more appropriate to use the indices presented in the book only as part of a screening process.
After that, you can do other, more in-depth analyses to confirm or deny whether these companies are good investments, and thus you can feel more confident and invest in them. I hope you enjoyed the video. If you can, leave a like. Like and subscribe to the channel, and if you want me to make more summaries about other expiration dates, just leave your suggestion in the comments; it will be very welcome. Until the next video, and a big hug!
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