The Little Book That Beats the Market Book Summary

The Little Book That Beats the Market Book Summary

The Little Book That Beats the Market Book Summary:

“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

― Joel Greenblatt, The Little Book That Beats the Market

The little book that beats the market is a classic value investing book, which was originally written in 2005.

This book educates a magic formula, which is simple yet effective and if patiently practiced, then is guaranteed to make profits in long run.

About the Author:

Joel Greenblatt is an American investor, hedge fund manager, and a writer. He started an investment company named ‘Gowtham capital’ in 1985. This firm has given an impressive 40% annualized return for a duration of 20 years from 1985 to 2006.

Joel has dedicated the book ‘The little book that beats the market’ to his children and hence is written in a simple story-telling format, which anyone can read and easily understand.

‘The little book that beats the market’ became an instant best-seller when published and over millions of copy of this book has been sold.

Joel is a long-term investor and generally holds the stocks for more than a year in his portfolio. He believes that the market can be erratic in short term, however, for the long-term stock market is quite efficient.

In addition, Joel has also created a website for magic formula investing which you can visit here.

The Little Book That Beats the Market Book Summary:

The book focuses on a magic formula which is based on two financial ratios- Return on capital and Earnings Yield.

1. Return on capital:

ROC = EBIT/ (Net working capital + Net Fixed capital).

Here, ROC is the ratio of the pre-tax operating earnings (EBIT) to tangible capital employed (Net working capital + Net fixed capital).

Joel Greenblatt has described why he used ROC in place of the commonly used financial ratios like ROE (Return on equity) or ROA (Return on assets). This is because, first of all, EBIT avoids the distortions arising from the differences in tax rates for different companies while comparing.

Second, net working capital plus net fixed capital is used in place of fixed assets as it actually tells how much capital is needed to conduct working of the company’s business.

Return on capital tells how efficient the company is in turning your investments into profits.

2. Earning yield:

Earning yield = EBIT / Enterprise value

Here, enterprise value is the market value of equity (including preferred shares) + net interest – bearing debt.

Earning yield how much money you can expect to make per year for each rupee you invest in the share.

Overall, ROC tells how good is the company and Earning yield tells how good is the price.

Also read: 10 Must Read Books For Stock Market Investors.

Next, here are the three steps suggested by the author Joel Greenblatt in his book ‘the little book that beats the market’ to find companies for investment:

  1. Find the earning yields and return on capitals of the stock to evaluate stocks.
  2. Rank the companies according to the above two factors and combine them to find the best companies for investment.
  3. Have patience and remain invested for the long term. Lack of patience is why people fail to implement the magic formula.

the little book that beats the market

How to use magic formula?

  1. Find the Return on capital (ROC) and Earning yield (EY) for all the companies.
  2. Sort all the companies by ROC.
  3. Sort all the companies by EY.
  4. Invest in top 30 companies based on the combined factors.
COMPANY SYMBOL ROC (RANK) EY (RANK) COMBINED (RANK)
A 1 153 154
B 2 35 37
C 3 37 40
D 4 480 484
E 5 13 18
F 6 127 133
G 7 78 85
H 8 512 520

Here, we try to find the companies with lowest combined factor rank.

For example, for company A, although it ranks 1 for the Return on capital. However, its earning yield rank is quite low and that’s why it’s combined rank is quite high.

On the other hand, for the company E, both ROC and EY rank are decent and hence its combined rank is good for investment.

Joel Greenblatt has researched on the top stock picks using this magic formula and found consistent good returns over long term.

Also read: How to get RICH? Rich Dad’s Cashflow Quadrant Summary

Conclusion:

The little book that beats the market is a nice read and an excellent place to start reading if you have never invested in stocks before.

The book is written in a very simple language and the concepts described in the book are time-tested.

You might think that why should I read the book when I have already given you the magic formula. This is because I have just explained a single chapter from the book. Think how much knowledge you can gain by reading the entire book.

Moreover, as the name of the book suggests, it’s a very little book with just 179 pages. You can easily read the book over a weekend and strengthen your financial concepts.

I highly recommend you to read this book, especially if you are a beginner. You can buy the book from Amazon. Here’s the link.

That’s all. I hope that this post on ‘The Little Book That Beats the Market Book Summary’ is useful to the readers.

Do comment below which is the best share market book that you have ever read.

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About Kritesh Abhishek 106 Articles
Hi, I am Kritesh. I'm 23, Electrical Engineer, Investor & Blogger. I have a passion for stocks and has spent my last 3 years learning, investing and educating people about stock market investing. And so, I delighted to share my learnings with you on this blog. #HappyInvesting

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