The Little Book That Beats the Market Summary: Joel Greenblatt’s Magic Formula
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Two numbers, one ranking, and a holding rule that most readers break
Published: 17 October 2026 · Last updated: 17 October 2026 · By Spencer Li, CFTe
What is The Little Book That Beats the Market about? Joel Greenblatt’s book teaches one idea: buy good companies at bargain prices, and keep doing it for years. He turns that idea into a simple ranking he calls the magic formula. It scores companies on 2 numbers, how much profit the business earns on the capital it uses, and how cheap the company is next to those profits.
In his test from 1988 to 2004, a portfolio of about 30 top-ranked stocks returned about 30.8% a year, against about 12.3% for the market average. But the book’s most useful chapter is about the bad years. The formula trailed the market in about 1 year out of every 4, and the book warns how hard it is to keep going through those stretches.
This summary covers the first edition, published in 2006. A revised edition, The Little Book That Still Beats the Market, came out later.
Who is Joel Greenblatt?
Greenblatt is a professional investor and a teacher. The book’s introduction describes “more than 25 years of investing professionally” and “9 years of teaching at an Ivy League business school.”
The book began, in his words, as a gift to “each of my five children.” It opens with a sixth grader who sells chewing gum at school, and asks how much half of that little business would be worth to a buyer who wants a fair return. The rest of the book builds from there, in plain language, for a reader who has never valued a business before.
What are the 2 numbers in the magic formula?
The formula has 2 numbers, plus a holding rule that makes them work.
Return on capital. This asks how much the business earns on the money tied up in running it. Greenblatt measures it as operating profit (EBIT) divided by net working capital plus net fixed assets. A business that earns a lot on a little capital tends to be a good business. It often has something competitors cannot easily copy.
Earnings yield. This asks how much the business earns compared with what you pay for all of it. Greenblatt uses operating profit divided by enterprise value, which counts the company’s debt as well as its shares. A high earnings yield means you are paying a low price for those profits.
The method is a ranking. He takes a list of the largest 3,500 companies, ranks each one on both numbers, adds the 2 ranks together, and buys the companies with the best combined score. So a company that is very good but expensive, or very cheap but poor, falls down the list.
Do note why he bothers with both numbers. A cheap company with a poor business can stay cheap for a reason. A great company at a high price can still be a poor investment. The formula looks for the overlap.
What did the backtest show?
Here are the headline results the book reports, for 1988 to 2004.
| Measure | Magic formula | Market average | S&P 500 |
| Average yearly return, 1988 to 2004 | 30.8% | 12.3% | 12.4% |
| 2002, the worst year for the formula | −4.0% | −24.2% | −22.1% |
| 2000 | 7.9% | −16.8% | −9.1% |
| 1990 | 1.7% | −16.1% | −3.1% |
The book’s “market average” is an equally weighted index of the same 3,500 stocks, so each stock counts the same. The S&P 500 counts large companies more heavily.
He also split all the stocks into 10 groups by their magic formula rank. The top group returned 17.9% a year and the bottom group 2.5%, with the returns falling almost step by step in between. For a ranking method, that order matters more than the headline number. It suggests the 2 measures carry real information, beyond a lucky top 30.
Do note this is a backtest. The author ran it on past data before the book came out, so returns after publication are a separate question, and the book itself spends a full chapter warning how uneven the ride can be.
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Why do most people fail with the magic formula?
This chapter is the reason to read the book. Greenblatt is blunt about how often the formula looked broken, even in his own winning test period.
In his words, the formula “fared poorly relative to the market averages in 5 out of every 12 months tested.” On a full-year basis, it “failed to beat the market averages once every four years.” For “one out of every six periods tested,” it lagged for more than 2 years in a row. And over any 3-year stretch, it “beat the market averages 95 percent of the time (160 out of 169 three-year periods tested).”
So the formula worked over 3 years. Over 1, it often failed. That is exactly the pattern that makes people give up. A year of trailing the market feels like proof that the method has stopped working.
A trader asked on an investing forum in 2019: “Has Greenblatt’s magic formula stopped working?” The book’s own figures suggest why that question keeps coming up, because by its own count the formula trailed the market in about 1 full year out of every 4, even within the test period the book reports.
That is why the holding rule matters as much as the 2 numbers. His step-by-step plan asks you to “be committed to continuing this process for a minimum of three to five years, regardless of results.”
The same idea applies to any method with an edge. A short run of results tells you very little. Our post on the law of large numbers in trading explains why.
How does Greenblatt say to use the formula?
His plan, in short:
- Buy 5 to 7 top-ranked companies, using only 20% to 33% of the money for the first year.
- Repeat every 2 to 3 months, until you hold 20 to 30 stocks after about 9 or 10 months.
- Sell each stock after holding it for 1 year, and replace it with a new top-ranked one.
- Keep going for at least 3 to 5 years.
For readers using their own stock screener, he offers a stand-in: a minimum return on assets of 25%, then the lowest price-to-earnings ratios from that group. He also says to exclude utilities and financial stocks.
Should you pick stocks with the formula at all?
Here the book takes a turn many readers do not expect. Chapter 10’s summary opens: “Most people have no business investing in individual stocks on their own!” Point 2 reads, “Reread summary point number 1.”
His reason is that valuing a business well is hard. If you cannot estimate a company’s normal earnings several years ahead, a mechanical formula or a broad index is the safer path. Readers who want the index route can start with our guide on how to choose an index ETF from Singapore.
For the value-investing ideas that sit underneath the formula, our summary of The Intelligent Investor covers Mr. Market and the margin of safety. And for the case for owning the whole market at low cost, see our summary of The Little Book of Common Sense Investing.
Concluding thoughts
The Little Book That Beats the Market is short, and the method fits on a page. The hard part is the patience. The book is honest that the formula spent long stretches looking wrong, even in its best test.
More books worth your time are in our list of the best investing and trading books.
So here is the book’s real test. Could you stick with a method that trailed the market for 2 years in a row?
FAQ
What is the magic formula in The Little Book That Beats the Market?
It ranks the largest companies on 2 measures, return on capital and earnings yield, then buys the ones with the best combined rank. The aim is good businesses at bargain prices.
Does the magic formula still work?
The book’s test covered 1988 to 2004 and was run before publication. The book itself warns the formula can trail the market for 1 to 3 years at a time, so short periods tell you little either way.
How many stocks does the magic formula hold?
The book suggests building up to 20 to 30 stocks, buying 5 to 7 at a time every 2 to 3 months, and holding each for about 1 year.
What is the difference between the 2 editions of the book?
The original came out in 2006. A revised edition, The Little Book That Still Beats the Market, followed. This summary is based on the original text.
Is The Little Book That Beats the Market good for beginners?
Yes. It was written for readers with no background in finance, and it explains return on capital and earnings yield with simple examples.
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About the author. Spencer Li is the founder of Synapse Trading and a Certified Financial Technician (CFTe) with over 15 years of trading across stocks, forex, crypto, commodities, and bonds. His trade log is public: every trade since April 2024, dated, losses left in. He teaches low-risk swing trading in 15 minutes a day, one system for any market.
Educational content only, not personalised financial advice. Trading carries risk, including loss of capital. Past performance is not indicative of future results. Synapse Trading is not licensed or regulated by MAS.
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Educational content only, not personalised financial advice. Trading carries risk, including loss of capital. Past performance is not indicative of future results. Synapse Trading is not licensed or regulated by MAS.
