How does the Magic Formula stock screener choose stocks?
First, there is nothing “magical” about the formula. Similar formulas also work quite well. Over the last 30 years we have seen many studies that demonstrate that “value” strategies-such as buying stocks with low price/earnings (P/E) ratios can outperform the market averages. In the case of the Magic Formula system, we are screening for stocks with low P/E ratios (“cheap stocks”) that also achieve high returns on capital (“good companies”). We then make some slight accounting adjustments to these commonly used ratios in order to be more accurate for comparison purposes across various companies.
