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If I tell you something now, see if you can believe it. We think of the stock market as the most complex sector in the world, dominated only by the most intelligent people . Isn't it? Yes, everyone generally has that thought . But would you believe me if I told you that a mathematical formula so simple that even a 10-year-old child could understand it has consistently yielded profits twice as high as those of the biggest experts on Wall Street who earn billions of dollars ?
Wow, that 's really surprising to hear. You definitely don't need an MBA degree, and you don't need any complicated diagrams. In this in-depth conversation we're going to have today, we're going to unlock the secrets of Joel Greenblatt's The Little Book That Beats the Market for you. That means what that book says is not just magic.
The basic logic behind it is very, very deep. Today, we're going to break down why this simple formula works so much better than the tricks used by stock market experts . I'm very interested. We're going to look at how you can make a big difference in your investment journey, not just with philosophies, but with data.
Okay, before we get into this magic formula, we need to understand one basic thing. How do we evaluate a business like that? Well, Joel Greenblatt gives a great example to help you understand what determines whether it's a good business or a bad business. Now let's take someone like Jason. He runs shops that sell pearls like Jason's [ __ ] Shops .
Okay, the candy shop. Let's say it costs him four hundred thousand dollars to build a complete store, buy supplies, and start the business . Four hundred thousand dollars is a very large investment. Okay, he's opening a shop after spending so much. How much profit does he make per year? One of his stores generates a net profit of 200,000 dollars a year.
I'll do the math in my head for a minute . An investment of 400,000 dollars yields a profit of 100,000 dollars in a single year. Yes, you are right. That means he makes a profit of 50% of his investment in a single year. Is this really possible? In real-world business, 50% profit is an incredibly large growth.
What I'm saying is that it's very rare, but it's definitely possible. This is what they call return on capital in the financial industry . Oh, how quickly the money you invest comes back . This refers to how quickly and how much profit an investment in a business generates. Now let's look at Jason's friend Jimbo.
Okay, what is Jimbo doing? He just opens a shop selling broccoli under the name of broccoli. The construction cost for him is the same four hundred thousand dollars. Okay, the same investment for both of them. But he only makes $10,000 a year . Oh my god, I invested 400,000 dollars and only made a profit of 10,000?
Yes, that means his return on investment is only 2%. Even if he had put that money in a regular bank account, he would have earned more interest without any effort . That's the important point here. Jason and Jimbo both invested the same amount of money . But Jason's business is many times more powerful in generating profits.
This is like the difference between buying a thriving tree that bears lots of fruit and buying a withered branch that never bears fruit . Very wonderful comparison. It's a waste to pour water on a dead tree. This is the first rule when it comes to investing. We need companies like Jason's business that can give us a high return on capital.
There are no companies like Jimbo's business. This is very clear to me. No one would want to invest in a gym. Jason's shop will be everyone's choice. But I have a doubt here. Listen, what's the doubt? If Jason's business yields a 50% profit a year, it's a goose that lays golden eggs. Why is Jason going to sell that word to me for such a cheap price ?
Fair question. He will definitely ask a very high price for his share. Would it be profitable for me if I bought that stock at a higher price ? You asked a very good question. How good a business is is only one side of the coin. What price you pay for it is the other side of the coin. Oh, I want to see both.
This is exactly why we use the second metric, earnings yield. Please explain this in a simple way . We'll take Jason's shop. Let's say Jason sells you a share of his store for $12. Okay, I'll buy it for 12 dollars. After you buy it, you get a profit of 1.20 per share per year . Oh, that means I'm getting a dollar and 20 cents back for the $12 investment I made.
Yes, if you look at the percentage, the return on your investment is 10%. So, is this 10% a good profit? What am I comparing this to? For that, we need to take a risk-free investment as a benchmark. For example, if you invest in US government bonds, you will earn 6% interest without any risk. If that's the case, I get 6% without taking any risk .
But when I become a partner in Jason's store and take the risk of experiencing the ups and downs of the business, I get 10%. Correct, I can conclude that the $12 is a fair price because the extra profit is worth the risk I'm taking . You got it right. That's why we see a business as better based on return on capital .
We see that the stock is available to us at a cheaper price due to the high earnings yield . It works like two builders. Yes, buying the best companies at the cheapest prices is the basis of this. It 's too much to ask. But how is this possible in the real world stock market ? Why do you ask that? Now take giant companies like General Motors or General Electric .
These companies do business worth billions of rupees. Surely, their factories or production capacity are not going to be halved in a year. Likewise, it doesn't happen twice in the same year . True. If that's the case, why do their stock prices experience such severe fluctuations in the stock market every day and every month?
Why should prices change if the actual business doesn't change ? To understand why the stock market behaves the way it does, we need to leave the numbers behind and delve into human psychology. An investment genius named Benjamin Graham explains the stock market without psychology through a very beautiful fictional character.
He likens the stock market to Mr. Market. Who is Mr. Market? Imagine that this Mr. Market is a partner in the business you run. But he has a problem. He is an emotional, eccentric man whose moods change frequently. Is he a strange person who behaves differently every day? Yes, he will be extremely excited in a few days .
He will try to buy your shares at a very high price, imagining that the world is so beautiful and that business is going to skyrocket. Oh, the height of greed. Correct, he will become extremely depressed in a few days . Fearing that the future is bleak and the global economy is about to collapse, he will come forward to sell even the best businesses, even amazing businesses like Jason's shop, at a very low price.
Then he won't care about the true value of the company, he will only act based on his fear. Ah, so the stock market is not an accurate calculating machine. You say it's a manifestation of human fear and greed. One hundred percent true. When Mr. Market's mood changes frequently, we should take advantage of it and profit.
That's the ultimate secret to investing. When Mr. Market gets scared and depressed and offers to sell a great company's stock at a very cheap price, you should buy it. Is this what they call the margin of safety ? Yes, Benjamin Graham calls this the margin of safety . I'm reminded of a wonderful comparison for this safety margin .
Now, let's say that when engineers build a bridge, they calculate that the bridge must withstand a maximum weight of 100,000 kilograms . Well, they wouldn't build it to withstand 10,000 kg of weight, absolutely not. They would build it very strongly to withstand 30,000 kg of weight, so that if an unexpected fault or storm comes, the milk wouldn't collapse.
That's right, the remaining 20,000 kg is their safety. Similarly, we have calculated that the true value of a share is 70 dollars . When Mr. Market gets depressed and comes to sell the stock for $37, we buy it. Yes, that's the right time. Even if there is a small error in our calculation tomorrow and the actual value is $60, we will not lose.
Because we only bought it for 37 dollars. This is an excellent comparison. That is the whole philosophy of security. So our goal is clear. We need more profitable Jason stores. And that too, when Mr. Market is depressed, it should be available at a very cheap price with a safety net. The goal is clear.
But in practice, how big a task is this? There are thousands of companies on the American stock market . Yes, there are more than 3000. Every day I sit in front of the computer and figure out which company gives the highest return on capital. Can you keep looking for which company Mr. Market has set the cheapest price ?
This is impossible. Is this where Joel Greenflat's magic formula comes in ? You are right. He created this formula to reduce human labor, set aside emotions, and make decisions purely logically . Wow, the way this formula works is very interesting. For the first time, a computer took over the 3,500 largest companies on the US stock market.
Okay, 3500 companies. How does this computer rank it? Please explain a little more. The computer creates two separate lists. The first list ranks those 3,500 companies from one to 3,500 based on return on capital . That is, whatever is the best business will be in first place and whatever is the worst business will be in last place .
Correct, this is a list for business standards . Next, create a second list . It is based on earnings yield . Price list? Yes, the company whose stock is available at the cheapest price will be in first place, and the one whose stock is offered at the highest price will be in 3500th place. Now the computer adds these two sets of values.
Oh, that means a company can be ranked number one. But if it was ranked 3000th in price, its total score would be 3001. That's why we should n't buy that share. Because it's very expensive. Okay? Very good. At the same time, it may be a boring business for someone to do. Let's say it's ranked 50th .
But Mr. Market put it in tenth place in terms of price because no one wanted to buy it. So the total score is 60. Yes. This score is very low, so this is a high-quality company. At the same time, the computer showed that it was very cheap. This magic formula selects the top 30 best companies for us based on the total scores .
Wow, this is so simple. So what would have happened if we had invested using this formula? Are there any real statistical sources for this? Absolutely. The results will truly amaze you. They tested this using data from the last 17 years . What are the results? The average stock market return over those 17 years was 12.3% per year .
But those who invested in stocks selected based on this magic formula have earned a return of 30.8% per year. What is it? 30.8% annual return? If you earn 30% profit for 17 consecutive years, not just one year, not two years, even a simple investment would have turned into millions. Yes, this is two and a half times more than the market average .
One minute. A big alarm bell is ringing in my head right now . What is that? This formula is so simple. A computer automatically sorts everything out . If the profits are so huge, why don't all the experts managing billions of dollars on Wall Street use it? Why doesn't everyone in the world use this formula and become millionaires?
Very important question. There must be a big problem, a catch, in this . You've come to the right point. There's no problem with the formula. The math and logic work perfectly with it. But do you know where the biggest problem lies? Where is it? The biggest enemies of this formula are human psychology and impatience within the human brain.
Impatience? What kind of patience does this require? The hidden truth here is that this formula doesn't work consistently every month and every year. Statistically, this formula performs worse than the market's average return for five out of 12 months. Five months of loss or low profit in 12 months.
Okay, okay, let's just put up with this. Not only that, sometimes your portfolio may show a profit or loss that is much lower than the average market return for two or three consecutive years . Wow, do you know how big of a shock this is? It's been two or three years. I rely on this formula for all my savings .
But my investment has been losing money for three consecutive years. Imagine . How difficult is that? At the same time, my neighbor, who knew nothing about the stock market, was making a profit by investing his money in some ordinary fund . How can I bear this ? What a fool I was to think that I would throw that formula in the trash and come out.
That's where many people are hanging out. Wall Street experts also have the same mindset as you just mentioned . You've probably heard why professional investors don't use this, right? Oh, what's wrong with them? The main reason for that is the fear of losing their jobs . That is, career risk. Will I lose my job?
How? Imagine a Wall Street fund manager investing billions of dollars using this magic formula . The first year, the profit is lower than the market. Customers will grumble. Did you make a loss the second year? That's all. All customers will ask for their money back. That fund manager will be fired.
Oh. You have to wait with extreme patience for three to five years for this formula to work fully. But Wall Street experts don't have the freedom to exercise that patience. What matters to them is short-term profit. Now I have that big aha moment . Wall Street experts can't do this. Because they have pressure from customers .
But as an ordinary investor, I do n't have any clients. I don't have any friends. Yes, you are the boss of your money. I'm not going to sleep after work. I can definitely wait for three to five years in peace. This is the greatest strength of ordinary investors. You have understood it very clearly. That's what Joel Greenblatt insists on.
The real purpose of Wall Street experts is not to make you a profit . What are they doing behind the scenes? Brokers want to sell you a share and get a commission. Mutual funds charge you a large amount of management fees . But they often give lower profits than the market. Hedge funds can be profitable.
But they will take 20% of your profits without any hesitation. So, are index funds better? There's no big risk in that. Investing in index funds is safe. But that will only give you average profits. If you want to beat the market and make big profits, the only way is to invest yourself using the magic formula .
Okay, I understand. Wall Street negotiators cannot be trusted. We have to invest ourselves . For that, can I go to the stock market tomorrow and choose and invest in a few stocks that I think are right for me, based on some criteria ? This must be easier than the magic formula . Oh my! Don't make such a mistake .
A sentence in the source warns against this very strongly. What sentence is that? Picking stocks on your own without any logical formula and without understanding the emotions of Mr. Market is like running into a dynamite factory with a burning match . Run to the fire burning inside the dynamite factory?
That must be terrible to hear . Yes. You might be lucky to survive once. But continuing to do so will completely destroy your investment . If you want to beat the market, you have to follow a system. That means a system of order is needed. You should definitely use the magic formula and divide your investment into 20 to 30 best stocks.
You need to control your emotions and be patient, not afraid of short-term market declines, for three to five years . That's the only way to win the market. This is a wonderfully eye-opening discussion. For those of you listening, I'll give you a quick summary of what we've talked about so far . The stock market is not some incomprehensible magical phenomenon.
Oh, it's just a market. We need to be vigilant and use that margin of safety when Mr. Market gets carried away by his emotions and tries to sell good companies at a low price . There is no angel magically protecting you on Wall Street . They ca n't be patient. But you can do it. Correct. Two simple metrics - Return on Capital and Earnings Yield - are the foundation of that magic formula .
Your patience in following this will make you successful. There is no doubt that knowledge, patience, and emotional control are the only weapons that will support you in investing. Finally, I'll leave you with an important point for you to ponder . We saw that for this magic formula to work, we had to act completely against the natural human mindset, that is, the herd mentality of going in the same direction as everyone else .
That is a very difficult thing. Even if those around you think you're stupid, you have to be stubborn about your decision for two or three years. Think about what other areas of your life you could dramatically improve beyond this investment if you could control your emotions and act courageously, as is your nature .
If you have the ability to identify the right tree for you, you can reach the pinnacle of profitability in any field. We meet you again with an interesting topic. Continue to seek knowledge.
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