Choosing stocks for investment is not an easy task. You have to read years of annual reports, study the industry in which the company is operating and then we need to do the valuation. It requires a lot of study and research. Things can be made easy by filtering the stocks on certain parameters suggested by some great investors. One such stock filtration formula is the magic formula.

Magic formula was invented by Joel Greenblatt, the author of The little book that beats the market for his Children who were aged between 6-15 at the time. The formula is designed for kids, it involves very basic maths and is easy to understand for everyone.

Greenblatt says about the formula in the book.

a long-term investment strategy designed to help investors buy a group of above-average companies but only when they are available at below-average prices.

Below is the formula as described by the Wikipedia page

1. Establish a minimum market capitalization (usually greater than $50 million).
2. Exclude utility and financial stocks.
3. Exclude foreign companies (American Depositary Receipts).
4. Determine company’s earnings yield = EBIT / enterprise value.
5. Determine company’s return on capital = EBIT / (net fixed assets + working capital).
6. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages).
7. Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period.
8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
9. Continue over a long-term (5–10+ year) period.

I am twisting the formula a little bit for Indian market

1. Select companies above market cap of 400 crore only
2. Remove financial stocks
3. Determine company’s earnings yield = EBIT / enterprise value.
4. Determine company’s return on capital = EBIT / (net fixed assets + working capital).
5. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital

I ran the query on Screener.in and got these 30 stocks

This magic formula has outperformed S&P500 96% of the time. Let us test how this magic formula works for Indian stocks. I am picking 20 stocks from the magic formula filtered stocks, eliminating some stock of the same sectors and companies with higher debt.

We are virtually investing 10,000 Rs in each stock and we will track how the portfolio performs in 12 months. After 12 months we will remove 2 stocks by booking profit in the best performer and loss in the worst performer and will replace these stock with other stocks from the magic formula screen. The portfolio sheet can be viewed here 

Update 4th April 2017 

Portfolio was up 48.5% in a year

Lycos Internet sold in loss of 55.2%  5515 Rs (buy price 17.9 sell price 8.5)
Bengal & Assam sold in profit of 272%  27225 Rs  (buy price 468 sell price 1744)
Net 21710 Rs of profit book after a year time

Bombay Burmah (price 850)and IST (price 775) bought in the portfolio

Update 4th April 2018

Portfolio was up 60%
Jindal Poly sold in loss of 37% , Buy price 518 Sell Price 328

IG PetroChem sold in a profit of 436% , Buy price 137 Sell Price 727

New stock added AlphaGeo at 780 and Balasore Alloy at 55

Update 16 April 2019

Eros sold in loss of 64%
KEI sold in profit of 287%
new stock added national peroxide and west-coast paper

Disclaimer: This article is for education and research purpose only not any investment advice. Kindly do your own research or consult your financial advisor.