A stock ranking strategy analyzing companies' return on capital and earnings yield to identify potentially undervalued stocks with strong financial performance.
Explore complementary indicator rolesHow it works
The Magic Formula strategy evaluates stocks by calculating two primary financial metrics: Return on Capital (ROC) and Earnings Yield (EY). ROC is determined by dividing EBIT by the sum of net working capital and net fixed assets, while EY is calculated by dividing EBIT by enterprise value.
After computing these metrics, investors rank stocks based on their performance in both categories. Companies are then sorted by the combined rank, with lower total rank values indicating more attractive investment opportunities. This systematic approach allows investors to systematically screen and select potentially undervalued stocks with strong financial fundamentals.
Why it may be useful
The Magic Formula provides a disciplined, quantitative approach to stock selection that removes emotional bias from investment decisions. By focusing on fundamental financial metrics, investors can identify companies with strong operational efficiency and attractive valuation characteristics.
This method offers a structured framework for identifying potentially undervalued stocks across different market conditions. It helps investors move beyond subjective assessments and relies on concrete financial data to make more informed investment choices.
When to explore it
The Magic Formula strategy is most effective when applied to a diverse universe of large-cap or mid-cap stocks trading on major exchanges. It works best as a long-term investment approach, typically over periods of multiple years rather than short-term trading.
Investors should consider using this strategy during market conditions where fundamental analysis can reveal hidden value. It is particularly useful for those seeking a systematic, rules-based approach to stock selection that minimizes emotional decision-making and focuses on financial performance.
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What we’ve verified
Access, alerts and repainting behaviour have not been independently verified for this indicator. Check the creator’s current publication and settings.
General descriptions and classifications are recovered research. Verified details above identify the specific checks we have completed. Check the creator’s current publication for later changes.
