🎯Joel Greenblatt's Magic Formula: Building an ETF Portfolio That Beats the Market

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Welcome back, ETF UNO readers! Today marks an exciting new chapter in our legendary portfolio series as we explore the investment wisdom of Joel Greenblatt. His name should be on every value investor's radar. If you've been following our series, you know we enjoy examining how investors can adapt the strategies of legendary investors for modern ETF portfolios. Get ready because Greenblatt's approach may be the most accessible yet powerful strategy we've discussed so far.

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🔮Meet the Magician Behind the Formula

Joel Greenblatt is a notable figure on Wall Street and the author of a popular method for beating the market systematically. As the founder of Gotham Asset Management and an adjunct professor at Columbia Business School, he achieved an impressive average annual return of 40% over 20 years through his hedge fund from 1985 to 2005—an accomplishment that would impress even Warren Buffett.

What sets Greenblatt apart is his willingness to share his investment strategies. He simplified his approach into the "Magic Formula", a strategy accessible to all investors. His book, "The Little Book That Beats the Market", became a bestseller, making value investing approachable for everyday people. The Magic Formula focuses on just two key metrics that, when combined, help identify companies that are both cheap and high-quality:

• Earnings Yield (EBIT/Enterprise Value): This measures how much bang you get for your investment buck. How much earnings am I getting relative to what I'm paying for this entire business? The market typically undervalues companies with high earnings yields.

• Return on Invested Capital (ROIC): This reveals how efficiently a company converts its capital into profits. High ROIC companies are the business equivalent of skilled chefs who can turn simple ingredients into gourmet meals—they know how to make money and work hard.

Greenblatt's approach combines Benjamin Graham's focus on undervalued companies with Warren Buffett's emphasis on quality businesses. This strategy isn't just about buying cheap stocks; it involves acquiring good businesses at bargain prices:

• 👑Prioritise quality: Investing in low-quality companies just because they are cheap leads to mediocre results.

• 📋Follow a systematic approach: A disciplined, rules-based strategy helps eliminate emotional bias.

• ⌛Be patient: The magic formula typically requires 3-5 years for meaningful outperformance.

• 🥧Diversify: Spread risk across 20-30 stocks rather than relying on a few.

• 🔄Rebalance regularly: This ensures you buy low and sell high.

• 🔍Look for market inefficiencies: Short-term emotions often misprice businesses, presenting investment opportunities.

Building a Greenblatt-Inspired Portfolio with ETFs📊

Here's an exciting update for ETF UNO readers. Although Greenblatt's strategy focused on individual stocks, we can adapt his principles with carefully selected ETFs. Let's examine five ETFs that embody his magic formula philosophy:

1. Gotham Enhanced 500 ETF (GSPY)

$GSPY ( ▲ 0.12% ) is as close to getting Greenblatt's direct expertise as possible—it's literally managed by his own firm, Gotham Asset Management! GSPY takes all 500 stocks in the S&P 500 Index but reweights them, buying more of the ones Gotham believes are cheaper and less of the ones they believe are more expensive, utilising an "enhanced" strategy based on his "quality + value" principles.

2. Avantis U.S. Small Cap Value ETF (AVUV)

Small-cap value stocks have consistently been top market performers, and $AVUV ( ▲ 0.2% ) effectively captures this potential. The fund invests in a diverse set of U.S. small-cap companies, targeting those with low valuations and high profitability ratios. This aligns with Greenblatt's focus on undervalued firms with strong fundamentals, particularly in sectors where mispricings are more common.

3. John Hancock Multifactor Emerging Markets ETF (JHEM)

$JHEM ( ▲ 1.12% ) highlights the importance of international diversification for U.S.-focused investors. Emerging markets often trade at discounts to developed markets, presenting opportunities for undervaluation that Greenblatt's formula captures. This strategy combines the growth potential of emerging markets with disciplined filters to avoid "value traps."

4. iShares Core S&P 500 ETF (IVV)

$IVV ( ▲ 0.21% ) tracks the S&P 500's investment performance, providing broad market exposure at low fees. While it doesn't use Greenblatt's screening criteria, it ensures you capture overall market returns as your targeted strategies operate.

5. Invesco S&P 500 Quality ETF (SPHQ)

$SPHQ ( ▲ 0.34% ) tracks the performance of high-quality stocks in the S&P 500 Index, based on return on equity, accruals ratio, and financial leverage ratio. It simplifies the "high return on capital" element of Greenblatt's formula by concentrating on the best companies in the index.

🎪From Wall Street Wizard to Your Portfolio

Greenblatt's magic formula has shown strong consistency across various markets and time periods, with research indicating outperformance in regions such as Finland, Brazil, Sweden, China, and Norway. However, potential risks include increased volatility and short-term underperformance.

For ETF investors, this approach is appealing because it helps remove emotion from the investment process. When markets become turbulent, a systematic strategy enables you to stick to your plan rather than making fear-driven decisions that harm long-term returns.

Utilising Greenblatt's principles through ETFs offers instant diversification with a focus on value and quality. This strategy minimises concentration risk while targeting successful investment factors. Greenblatt emphasises that his formula is most effective for 3 to 5 years, making it a strategy for gradual wealth accumulation that rewards patience and discipline.

Joel Greenblatt's "Magic Formula" offers ETF investors a systematic way to outperform the market by focusing on low prices and high returns on capital. By utilising his principles with selected ETFs, everyday investors can gain the same advantages that led to Greenblatt's success on Wall Street.

Our community of ETF investors is here to help you explore this exciting world and discover effective portfolio strategies. Keep learning, keep investing, and remember—great opportunities often lie in plain sight.

DISCLAIMER: This article is for informational purposes only and does not constitute investment advice. Always conduct your own research and consider consulting with a financial advisor before making investment decisions.