The Little Book That Beats The Market opens with a simple story about a boy selling bubble gum on the playground. The author and his son attempt to place a value on the business. In the end, it’s made clear that putting a value on a business is the key to investing in individual companies.
The Magic Formula In A Nutshell
The book concludes with a multi-page appendix that lays out how to apply the magic formula. Here’s that explanation in a nutshell:
Go to a website that lets you filter stocks by certain criteria (like this one at Yahoo!). Filter for stocks that have a ROA (return on assets) of at least 25%, then rank them according to their P/E ratios, with the lowest at the top. Toss out all stocks with a P/E lower than 5 (something’s fishy there), all utility and financial stocks, and all foreign stocks. Buy five or seven of these stocks a month for five months (or so). When you near a year of owning one of these stocks, if it’s at a loss, sell it when you’ve owned it one day less than a year and if it’s a gain sell it when you’ve owned it one day morethan a year (playing games with the capital gains tax, basically). Then reinvest what’s left. Keep doing this for at least five years. That’s it!
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