The Magic Formula: Return on Capital Meets Earnings Yield
"The secret to investing is to figure out the value of something — and then pay a lot less." — Joel Greenblatt
Joel Greenblatt's "Magic Formula" ranks companies on two simple measures at the same time:
- Return on invested capital (ROIC) — how good is the business at turning capital into profit?
- Earnings yield (operating profit ÷ enterprise value) — how cheaply does it trade?
A high return on capital signals a business that creates value. A high earnings yield signals a fair entry price. Ranking on both together points towards good businesses available at reasonable prices — rather than cheap businesses that are cheap for a reason.
Illustrative example: Monster Beverage (2007)
Around 2007 the company combined a return on invested capital above 40% with a cheap earnings yield relative to peers — exactly the combination the formula looks for. Its shares went on to perform strongly over the following decade. The example shows the two-axis idea at work; it is not a claim about any company today.
Educational only — not financial, tax, or investment advice, or a recommendation to take any particular course of action. Any names, figures, and examples illustrate a principle and are historical or simplified; past performance is not a reliable indicator of future results. Rules, tax treatment, and published figures change over time and may not reflect current policy. Wealth Diagnostics provides education and tools for financial advisers and their clients — seek licensed advice for your own circumstances before making any financial decision.