The Little Book That STILL Beats The Market- Summary
The author describes this book as a gift for his children. He reckons that if he could teach his kids to make money, then he could teach almost anyone to be a successful investor. He wants to convince you that most professionals can’t help you beat the market. Hence, you must do it yourself.
This books teaches you the Magic Formula, which you can use to beat the market, but you must first understand WHY it works. All in all, you will learn:
- How to view the stock market
- Why success eludes almost all individual and professional investors
- How to find good companies at bargain prices
- How you can beat the market by yourself
This book is for anyone who is looking for a simple yet magical formula to successful investing. If you are a more advanced investor, there is an Appendix section for your reference as well.
The book is littered with stories and anecdotes in order to help you better understand the investing world.
The first chapter illustrates to readers that even a simple business such as selling gums has a valuation to it. The key objective of any successful investor is to buy a business for a lot less than what it is worth. This book is going to teach you how to get rich. This book serves to provide you with a story that comes with a Magic Formula. Too good to be true? Read on to find out more…
Let’s get the basics right. You need money to grow money. You should save money and put them to good use. One of the safest investment tools will be bonds, particularly government bonds, which is almost risk-free. Therefore, that should be the benchmark for your return on investment. Of course, you can do something else with your money.
The next chapter continues with the story of Jason’s gum store. The store’s business is growing and getting more interesting. Yet all you need to understand is that:
- Buying a share in a business means you are purchasing a portion (or percentage of interest) of that business. You are then entitled to a portion of that business’s future earnings.
- Figuring out what a business is worth involves estimating how much the business will earn in the future.
- The earnings from your share of the profits must give you more money than you would receive by placing that same amount of money in a risk-free 10-year government bond.
The author then provided examples of real businesses in which their share prices fluctuate a lot, followed by this question – “Why do the prices of all these businesses move around so much each year if the values of their businesses can’t possibly change that much?” His answer to that is simple: Who knows and who cares? You just have to know that they do. Subsequently, the author introduced the concept of Mr. Market, which was first mentioned by Benjamin Graham in his book – “The Intelligent Investor”. The crazy guy Mr. Market is subject to wild mood swings and may offer you businesses at various prices. Graham referred to this practice of buying shares of a company only when they trade at a large discount to true value as investing with a margin of safety. This will lead to safe and consistently profitable investments.
Next, two concepts will be introduced, which are Return on Capital and Earnings Yield.
If you just stick to buying good companies (ones that have a high return on capital) and to buying those companies only at bargain prices (at prices that give you a high earnings yield), you can end up systematically buying many of the good companies that crazy Mr. Market has decided to literally give away.
The Magic Formula simply looks for the companies that have the best combination of those two factors. It works for companies both large and small. It often doesn’t work for several years in a row but it will work very well over the long term. Companies that earn a high return on capital may also have the opportunity to invest some or all of their profits at a high rate of return. This opportunity is very valuable. It can contribute to a high rate of earnings growth. By eliminating companies that earn ordinary or poor returns on capital, the magic formula starts with a group of companies that have a high return on capital. It then tries to buy these above-average companies at below-average prices. Although over the short term Mr. Market may price stocks based on emotion, over the long term Mr. Market prices stocks based on their value.
In summary, the author has spent chapters to convince the readers that the Magic Formula works.
If you are convinced, here are the 7 steps for you to follow and apply the Magic Formula:
STEP 1– Go to magicformulainvesting.com
STEP 2– Follow the instructions for choosing company size. For most individuals, companies with market capitalizations above $50 million or $100 million should be of sufficient size.
STEP 3– Follow the instructions to obtain a list of top-ranked magic formula companies.
STEP 4– Buy five to seven top-ranked companies. To start with, invest only 20 to 33 percent of the money you intend to invest during the first year.
STEP 5– Repeat Step 4 every two to three months until you have invested all of the money you have chosen to allocate to your magic formula portfolio. After 9 or 10 months, this should result in a portfolio of 20 to 30 stocks (e.g., seven stocks every three months, five or six stocks every two months).
STEP 6– Sell each stock after holding it for one year. For taxable accounts, sell winners after holding them a few days more than one year and sell losers after holding them a few days less than one year (as previously described). Use the proceeds from any sale and any additional investment money to replace the sold companies with an equal number of new magic formula selections (Step 4).
STEP 7– Continue this process for many years. Remember, you must be committed to continuing this process for a minimum of three to five years, regardless of results. Otherwise, you will most likely quit before the magic formula has a chance to work!
Summarised by Traven Teng.