Magic Formula Investing

You're taking your cow to market. You're supposed to get some cash to help get your family through winter. However, you meet a strange little man who offers to trade the cow for a magic formula for investing. You know how the rest of this story goes: investment in bean stalk futures and greenmail involving angry giants.

That's one kind of magic formula investing. However, the kind we're talking about here has a much more respectable pedigree. It's a value investing program popularized by writer Joel Greenblatt.

The "magic formula" involves ranking companies based on their earnings yield and return on capital (typically, you're supposed to focus on larger firms, limiting your scope based on market cap). Then you invest in 20-30 of the best ranked firms, building up positions slowly over time. Once a year, you re-balance your holdings.

The idea is to build positions in companies that do a good job turning their assets and revenue into profits. By going slow and rebalancing, you minimize market timing risk.