Case Study: Using Value Investing Joel Greenblatt to Uncover Investment Opportunities
Value investing Joel Greenblatt style is not about finding the cheapest stocks. It is about finding the cheapest good businesses. This distinction is the core insight of his Magic Formula and the reason it outperformed a naive low-P/E strategy in every historical period Greenblatt examined. A cheap stock with a poor business is often cheap for a reason that will not go away. A cheap stock with a strong business is often cheap because the market is looking at the wrong time horizon. This case study works through the Magic Formula logic on three real stocks, shows where it succeeds, and identifies where it needs supplementing.
Key Takeaways
- Value investing Joel Greenblatt's Magic Formula combines earnings yield (cheapness) with return on capital (quality) to find temporarily mispriced good businesses.
- The formula works mechanically over diversified portfolios held for one year. Individual picks are unreliable; the portfolio average is the edge.
- Real case data shows the formula correctly identifies high-quality businesses at fair-to-cheap valuations but occasionally misses deteriorating situations not visible in current earnings.
- Earnings yield uses EBIT/enterprise value, not P/E, to make companies with different debt levels comparable.
- The Piotroski F-Score overlaid on Magic Formula results removes roughly half of the deteriorating companies from the candidate list.
- Our guru tracker at ValueMarkers runs Greenblatt's ranking logic daily across 73 global exchanges, including Piotroski overlays.
When Did Warren Buffett Start Investing
Warren Buffett started investing at age 11 in 1941, buying three shares of Cities Service Preferred at $38 each. He began his formal investment partnership in 1956 after returning from studying under Benjamin Graham at Columbia Business School. This origin matters in the context of Greenblatt because Greenblatt explicitly positions the Magic Formula as an extension of Graham and Buffett's principles, not a departure from them. Buffett's famous statement that he would like to own "wonderful companies at fair prices" rather than "fair companies at wonderful prices" is precisely what the Magic Formula operationalizes: earnings yield captures the "fair price" dimension and return on capital captures the "wonderful company" dimension.
The Case Study: Three Stocks Through Greenblatt's Lens
Consider three companies across different sectors in early 2026. The goal is to see how the Magic Formula ranks them and whether the ranking aligns with a qualitative reading of each business.
| Stock | EBIT Margin | EV/EBIT | Earnings Yield | ROC Estimate | Magic Formula Rank Signal |
|---|---|---|---|---|---|
| Microsoft (MSFT) | 44.1% | 28.6x | 3.5% | 35.2% | Middle tier (quality high, yield low) |
| Johnson & Johnson (JNJ) | 26.3% | 12.8x | 7.8% | 27.4% | Upper tier (both factors solid) |
| Berkshire Hathaway (BRK.B) | Varies | 8.9x | 11.2% | Varies | Upper tier by yield; ROC estimate complex |
JNJ screens better than MSFT by the Magic Formula on current data. This surprises investors trained to view MSFT as the superior business. Both assessments are correct in different ways: MSFT has a stronger moat, but JNJ is trading at a significantly lower multiple relative to its operating earnings. The Magic Formula rewards the price dimension as heavily as the quality dimension.
What Is Book Value
Book value is total shareholders' equity on the balance sheet: total assets minus total liabilities. For a company with $10B in assets and $6B in liabilities, book value is $4B. Book value per share divides that by shares outstanding. The price-to-book ratio (P/B) compares the stock price to book value per share.
Greenblatt's Magic Formula deliberately avoids P/B as its primary cheapness metric, partly because book value is distorted by accumulated depreciation, goodwill from acquisitions, and accounting choices. Apple (AAPL) at P/E 28.3 and ROIC 45.1% has a very high P/B because decades of earnings retention and share buybacks have reduced book equity while assets remain large. A pure P/B screen would have you avoiding AAPL at almost any price, which would have been a costly mistake over the past decade. Earnings yield sidesteps this problem by using cash income rather than accounting equity.
What Is a Fair Value Gap
A fair value gap refers to the difference between a stock's current market price and an estimate of its intrinsic value. Greenblatt's Magic Formula identifies stocks where this gap is likely to exist: companies combining above-average earnings yield with above-average return on capital are statistically more likely to be trading below fair value than companies where only one factor is favorable.
The gap closes through two mechanisms. Mean reversion in valuation: as investors recognize the quality of the business, they pay a higher multiple for the same earnings. Growth in earnings: a high-ROC business generates returns that compound into higher earnings over time, lifting the intrinsic value even if the multiple stays flat. Both mechanisms work in the Magic Formula investor's favor simultaneously. Greenblatt's back-test showed that the formula outperformed regardless of which mechanism dominated in any given year.
What Is Intrinsic Value
Intrinsic value is the present value of all future cash flows a business will generate, discounted at an appropriate rate. Benjamin Graham defined it as the value "determined by the facts" as opposed to the market price "determined by supply and demand." Greenblatt operationalizes a simpler approximation: a high-quality business (high ROC) trading at a high earnings yield is priced below what its cash generation justifies. You do not need a precise DCF to recognize that a business earning 25% on its invested capital and trading at 10x EBIT is likely below intrinsic value.
Our DCF calculator at ValueMarkers lets you run four models, including a Greenblatt-informed approach that uses normalized EBIT margins as the base cash flow estimate, giving you a more precise intrinsic value estimate after the Magic Formula filter surfaces a candidate.
How to Calculate Intrinsic Value of Share
Calculating intrinsic value per share requires three inputs: a normalized earnings estimate, a discount rate, and a terminal growth assumption. The most common method is a discounted cash flow model. For Magic Formula users, the starting point is EBIT per share: take the company's EBIT, subtract taxes at the effective tax rate, and divide by diluted shares outstanding. This gives you after-tax earnings per share excluding the distortion of debt interest.
Then apply a multiple that reflects the business's growth rate and capital requirements. A high-ROC business reinvesting heavily earns more per dollar of retained capital, justifying a higher multiple. A low-ROC business earning 8% on retained capital should trade near book value, since it earns barely above the cost of capital. Greenblatt's framework implicitly runs this calculation by using return on capital to justify why the high-earnings-yield stock is cheap rather than simply deserving of a low multiple.
How Does Value Investing Work
Value investing works by exploiting the gap between price and value. Markets are efficient most of the time, meaning the price reflects all publicly available information. But markets are periodically irrational, either because investors overreact to bad news, because a sector falls out of favor temporarily, or because a company's earnings are depressed by a one-time event that clouds the underlying trend.
The value investor's job is to identify these gaps, buy when the price is below value, and wait for the market to recognize its mistake. Greenblatt's Magic Formula systematizes this process by making the search mechanical and broad. Rather than betting on your ability to identify one mispriced stock, you build a portfolio of 20-30 candidates and let probability work in your favor. Over 17 years of back-test data, the formula's average return of roughly 30.8% annually reflected this systematic approach rather than individual stock-picking skill.
Combining Greenblatt with the Piotroski F-Score
One well-documented enhancement to the Magic Formula is adding the Piotroski F-Score as an overlay. The F-Score measures nine binary signals across three categories: profitability trends, financial leverage changes, and operating efficiency improvements. A score of 8 or 9 indicates strengthening fundamentals; a score of 0 or 1 signals deterioration.
Research by several quantitative investing teams has shown that filtering Magic Formula candidates to only those with Piotroski F-Scores of 7 or above improves the portfolio's average return and reduces the incidence of value traps. The intuition is that the Magic Formula screens for current cheapness and quality but does not account for the direction of travel. The Piotroski filter adds that trend dimension.
| F-Score Range | Interpretation | Action |
|---|---|---|
| 8-9 | Strong, improving fundamentals | Strong buy signal alongside Magic Formula |
| 6-7 | Solid, stable fundamentals | Acceptable Magic Formula candidate |
| 4-5 | Unclear signals | Apply additional scrutiny |
| 0-3 | Deteriorating fundamentals | Exclude, even if Magic Formula rank is high |
What the Case Study Reveals About Greenblatt's Method
The JNJ example from earlier is instructive. At P/E 15.4, a 3.1% yield, and an EBIT/EV earnings yield near 7.8%, JNJ passes the cheapness test. Its pharmaceutical and consumer health segments generate consistently high returns on capital, passing the quality test. Its Piotroski F-Score as of early 2026 sits at 7, indicating stable fundamentals. By all three criteria, JNJ is a Magic Formula candidate.
MSFT at P/E 32.1 and ROIC of 35.2% is a higher-quality business but a worse Magic Formula candidate because its earnings yield is too low relative to its peers. It is an excellent company at a full price, which is exactly what the formula is designed to avoid.
BRK.B at P/E 9.8 and P/B 1.5 has a compelling earnings yield, but the ROC calculation is complicated by Berkshire's structure as a holding company. Greenblatt's formula works best on operating businesses with a clear capital base. Berkshire's ROC reflects both its insurance float advantage and its equity portfolio returns, making a direct comparison unreliable.
Further reading: SEC EDGAR · Investopedia
Why greenblatt magic formula case study Matters
This section anchors the discussion on greenblatt magic formula case study. The detailed treatment, formula, and worked examples appear in the body of this article above. The points below summarize the most important takeaways for value investors who want to apply greenblatt magic formula case study in real portfolio decisions. ValueMarkers exposes the underlying data on every covered ticker via the screener and stock profile pages, so the concepts in this article translate directly into actionable filters.
Key inputs for greenblatt magic formula case study
See the main discussion of greenblatt magic formula case study in the sections above for the full treatment, including the inputs, the calculation methodology, the typical sector benchmarks, and the most common pitfalls to avoid. The ValueMarkers screener lets value investors filter the full universe of 100,000+ stocks across 73 exchanges using greenblatt magic formula case study alongside the rest of the 120-indicator composite, with sector percentiles and historical trends shown on every stock profile.
Sector benchmarks for greenblatt magic formula case study
See the main discussion of greenblatt magic formula case study in the sections above for the full treatment, including the inputs, the calculation methodology, the typical sector benchmarks, and the most common pitfalls to avoid. The ValueMarkers screener lets value investors filter the full universe of 100,000+ stocks across 73 exchanges using greenblatt magic formula case study alongside the rest of the 120-indicator composite, with sector percentiles and historical trends shown on every stock profile.
Related ValueMarkers Resources
- Piotroski F-Score — Piotroski F-Score captures the reliability of reported earnings versus underlying cash flow
- Pb Ratio — Glossary entry for Pb Ratio
- DCF Intrinsic Value — DCF captures how cheaply a stock trades relative to its fundamentals
- Joel Greenblatt — related ValueMarkers analysis
- Joel Greenblatt Stock Screener — related ValueMarkers analysis
- Fidelity Vs Fisher Investments — related ValueMarkers analysis
Frequently Asked Questions
when did warren buffett start investing
Warren Buffett made his first stock purchase at age 11 in 1941. He formally launched his investment partnership in Omaha in 1956 after completing his studies under Benjamin Graham at Columbia. Greenblatt's Magic Formula is explicitly built on the foundation that Graham and Buffett established: buy quality businesses at prices below their intrinsic worth. Buffett's approach adds management quality assessment and moat durability analysis that the purely quantitative Magic Formula cannot capture.
what is book value
Book value is total shareholders' equity: total assets minus total liabilities. It represents the accounting residual that would theoretically belong to shareholders if the company liquidated at balance sheet values. P/B compares the stock price to this figure. Greenblatt avoids P/B as his primary cheapness metric because book value is distorted by accumulated depreciation, goodwill, and accounting choices. Earnings yield on enterprise value gives a cleaner picture of current income relative to the total cost of the business.
what is a fair value gap
A fair value gap is the difference between a stock's market price and its estimated intrinsic value. The Magic Formula identifies stocks where this gap is statistically more likely to exist: companies with above-average earnings yields combined with above-average returns on capital. The gap closes either through multiple expansion as investors recognize quality, or through earnings growth as the high-ROC business compounds its returns. Both work in the Magic Formula investor's favor simultaneously.
what is intrinsic value
Intrinsic value is the present value of all future cash flows a business will generate for its owners. Greenblatt's practical approximation: a business earning high returns on capital and trading at a high earnings yield is priced below what its cash generation justifies. The exact intrinsic value calculation requires DCF modeling, but the Magic Formula provides a systematic first-pass filter to identify candidates worth modeling in depth.
how to calculate intrinsic value of share
Start with after-tax EBIT per share (EBIT minus taxes divided by diluted shares). Apply a multiple that reflects the business's reinvestment rate and growth prospects. A business with 30% ROC reinvesting 50% of earnings grows intrinsic value by 15% annually, justifying a higher multiple than a business with 10% ROC and identical reinvestment. The VMCI score at ValueMarkers weights Value at 35% and Quality at 30%, which mirrors Greenblatt's two-factor approach at the portfolio level.
how does value investing work
Value investing buys assets at prices below their estimated intrinsic worth and waits for the market to recognize that gap. Greenblatt's version of value investing is systematic rather than discretionary: he defines cheapness as earnings yield and quality as return on capital, ranks a broad universe on both dimensions, and builds a diversified portfolio of the top-ranked names. The edge is statistical, not based on superior stock-picking judgment on any individual name.
Apply Greenblatt's ranking logic to your own research using our guru tracker, which screens 73 global exchanges with live earnings yield and return on capital data.
Written by Javier Sanz, Founder of ValueMarkers. Last updated April 2026.
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