Archive for May, 2006

Book Review: The Little Book That Beats the Market

May 1, 2006

9 comments
[Cover Image of The Little Book That Beats the Market]

Joel Greenblatt, a very successful hedge fund manager who also teaches investing at the Columbia University, promises to teach investors (including his children) how to produce market-beating returns with less risk with the help of a “magic formula”. He is not kidding with the “little” in the title: at slightly more than half the size of a regular hardcover, the book is only 155 pages long.

Setting aside the controversy (for a moment) about the actual returns produced by Mr. Greenblatt’s formula, I really enjoyed the book. There are so many personal finance and investing books to choose from and the vast majority are really old wine in a new bottle or sometimes the same wine in the same bottle with a new label. This book however is of the rare kind: it offers an original idea, is easy to follow and even if you are skeptical whether the formula will work in the future, it teaches the basics of investing using the example of a fictional business that sells bubble gum.

The magic formula presented in the book ranks stocks based both on the earnings yield and the return on capital (you can get a list of stocks selected by the formula on the Magic Formula Investing website. Use BugMeNot, if you want to bypass registration). The formula just attempts to find attractive businesses (with a high return on capital) that are selling at a bargain prices (a high earnings yield). Mr. Greenblatt has back-tested the formula on a point-in-time database (which eliminates survivorship bias) and says that a portfolio of 30 stocks selected using the formula and renewed every year would have returned 30.8% per year (compared to annual market returns of 12.3%) for the past 17 years.

There is some controversy over the margin by which the magic formula actually beats the market. For investors, this is a critical issue: If the formula triples the market return then it is probably worthwhile, but if it beats the market by just a few points, it may not be worth the extra drag of trading costs and ongoing capital gains taxes.

While I really liked the book and thought that the idea behind the magic formula made sense, I won’t be using it to select stocks for my portfolio. First, there is the chance that the excellent returns predicted by the formula might fail to materialize in the future. Second, the returns of the portfolio ignore trading costs and capital gains taxes. Having said that, the advice to buy good businesses at reasonable prices is timeless.

Another Book Giveaway: I will be giving away a copy of The Little Book sometime later this week (let’s say it is to celebrate Cinco de Mayo). Stay Tuned!

Carnival of Investing # 20

May 1, 2006

7 comments

Welcome to the 20th edition of the Carnival of Investing dedicated to posts that cover stocks, bonds, real estate or anything related to investing. Unfortunately, since I received only a handful of submissions, this edition will be short and sweet.

TIAA-CREF Funded my SEP IRA: Consumerism Commentary reports that TIAA-CREF finally managed to fund his SEP IRA account. The post talks about SEP IRAs in general and Flexo’s experience with TIAA-CREF in particular and also his fund allocation.

Spousal RRSP Scenario: Canadian Financial Stuff kicks off a series of posts to show how spousal RRSPs can be used to split income in retirement. Other posts in the series are available here, here and here.

Calculating and Comparing Treasury bill Returns: MyMoneyBlog shows how to decipher T-bill auction results and compares them to other cash-equivalent investments.

Special Situations Real Money Port Update: Fat Pitch Financials lists all the trades in his special situations portfolio and calculates the APY (IRR) of his performance so far. Hint: He is beating the markets by a substantial margin.

Audio Resources Around the Net: Investing the Middle Way provides an overview of some worthwhile streaming audio and podcasting financial programs around the internet.

Are Income Trusts A Ponzi Scheme: Le Revue Gauche worries about income trusts in Canada. He argues that this country has such poor regulations around capital and investments that it is literally the Wild West for all sorts of get rich quick schemes (like Bre-X).

Top Ten Mistakes that Investors Make: It’s Just Money lists the mistakes that investors too often make that results in poor portfolio returns.

Next week, tune in to Retire at 30 (I think) for more investing ideas.