Can There Be Actually A Magic Formula Just For Investing?
One question almost every single investor asks is whether it is possible to achieve market returns by choosing a diversified group of stocks in line with a formula, as an alternative to having to evaluate every single stock from every angle.
Lots of investment writers have proposed at least one such formulaic strategy during their lifetime. The most promising formulaic approaches have been articulated by 3 men: Benjamin Graham, David Dreman, as well as Joel Greenblatt.
As each of those approaches appeals to logic and common sense, they are not exclusive to these three men. But, they are the three names with which these strategies are usually most closely associated; so, there's very little need to draw upon sources beyond theirs.
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Benjamin Graham wrote 3 books: "Security Analysis", "The Intelligent Investor", and "The Interpretation of Financial Statements".
Inside of each book, he hints at numerous workable approaches both in stocks and bonds; on the other hand, he is most specific in his best known work, "The Intelligent Investor".
David Dreman is regarded as a contrarian investor. In his case, it can be an appropriate label, because of his keen interest in behavioral finance. Having said that, in most cases the line separating the value investor from your contrarian investor is fuzzy at best.
Dreman's contrarian investing techniques are derived from three measures: price to earnings, price to cash flow, and then price to book value. Of those measures, the price to earnings ratio is certainly the most conspicuous.
Finally, there's Joel Greenblatt's "magic formula". This is the most intriguing formulaic approach for investing, both since it does not subject stocks to any true/false tests and simply because it's a composite of the two most significant readily quantifiable measures a stock has: earnings yield and return on capital.
As you might recall, earnings yield is simply the inverse of the P/E ratio; so, a stock having a high earnings yield is basically a low P/E stock. Return on capital may be thought of as the quantity of pennies earned for each and every dollar invested within the business.
The precise formula that Greenblatt uses is described in "The Little Book That Beats the Market". Greenblatt states that his magic formula may be used in a couple of different ways: as an automated portfolio generation tool or as a screen.
For an investor like you (that's, one with enough curiosity and commitment to frequent an internet site such as this) the latter use could be the more appropriate one. The magic formula may serve you well as a screen.
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