Is There Really A Secret Formula Just For Trading?

One question almost every single investor asks is whether it really is possible to achieve market returns by choosing a diversified group of stocks in accordance with a formula, as opposed to having to evaluate each stock from every single angle.

Many investment writers have proposed at least one such formulaic method during their lifetime. Probably the most promising formulaic approaches have been articulated by three men: Benjamin Graham, David Dreman, as well as Joel Greenblatt.

As each of those approaches appeals to logic and common sense, they are not unique to these 3 men. But, these are the three names with which these methods are usually most closely related; so, there is very little need to draw upon sources beyond theirs.

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Benjamin Graham wrote three books: "Security Analysis", "The Intelligent Investor", as well as "The Interpretation of Financial Statements".

Within each book, he hints at numerous workable approaches both in stocks and bonds; on the other hand, he's most specific in his best known work, "The Intelligent Investor".

David Dreman is identified as a contrarian investor. In his case, it can be an appropriate label, because of his keen interest in behavioral finance. However, in most instances the line separating the value investor from the contrarian investor is fuzzy at best.

Dreman's contrarian investing methods are derived from 3 measures: price to earnings, price to cash flow, and price to book value. Of those measures, the price to earnings ratio is certainly the most conspicuous.

Finally, there is Joel Greenblatt's "magic formula". This really is the most interesting formulaic approach for investing, both since it doesn't 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 will recall, earnings yield is just the inverse of the P/E ratio; so, a stock with a high earnings yield is basically a low P/E stock. Return on capital might be thought of as the number of pennies earned for each and every dollar invested within the business.

The exact formula that Greenblatt utilizes is described in "The Little Book That Beats the Market". Greenblatt claims that his magic formula may be used in 2 different ways: as an automated portfolio generation device or as a screen.

For an investor like you (that is, one with enough curiosity and commitment to frequent an internet site such as this) the latter use is the more suitable one. The magic formula will serve you well as a screen.

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