Saturday, November 7, 2009

The Little Book That Beats The Market: Appendix

Joel Greenblatt, the book's author, is a value investor extraordinaire and a professor at Columbia's business school. In the book, Greenblatt discusses and justifies the "Magic Formula", a stock selection method that allows individual investors to beat the market using value investing.

For those convinced that the investment strategy encouraged by the book is a good one to follow, Greenblatt offers step by step instructions at the end of the book.

2) Follow the instructions for company size
3) Follow the instructions for a list of top-ranked magic formula companies
4) Buy 5-7 companies.
5) Repeat steps 1 to 4 every 2-3 months, which should give you 20-30 stocks for the year.
6) Sell each stock after holding for one year
7) Continue for many years. It's important to stick to the strategy, otherwise you may quit before it gets a chance to work.

Greenblatt ends the appendix with a discussion of the efficient market hypothesis, which suggests that the market is priced efficiently. While many studies have shown that various different strategies can beat the market, they have often suffered criticism for overlooking various aspects, such as increased risk, survivorship or look-ahead bias. Greenblatt asserts that the magic formula does not suffer from any of these biases, and works well for both large and small stocks.

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