Assessing the effectiveness of Greenblatt’s Magic Formula across international stock markets: Literature review

Abstract

This article presents a comprehensive literature review assessing the effectiveness of Joel Greenblatt’s Magic Formula in international equity markets. The strategy is a value-investing approach based on return on capital (ROC) and earnings yield (EY) metrics. Its primary objectives are to evaluate whether the strategy generates excess returns and to identify factors influencing its performance. The analysis synthesises empirical studies from the US, European (primarily Nordic), Brazilian and Asian markets, incorporating methodological considerations such as data sources, investment universes and systematic biases (e.g. look-ahead bias and survivorship bias). Key findings reveal that the Magic Formula outperforms benchmarks in most markets; however, its effectiveness is contingent on transaction costs (frequently eroding alpha), firm size, market conditions and metric modifications. Simpler strategies (e.g. those relying solely on EY) occasionally yield superior results. The review concludes that the Magic Formula represents a robust, albeit imperfect, tool for exploiting stock market inefficiencies. Future research directions include analyses of post-2020 periods, formula modifications and hybrid approaches.