MagicDiligence
How It Works

Finding the Best Magic Formula Stocks

MagicDiligence combines a proven quantitative stock ranking system with AI-assisted due diligence to help you identify quality stocks at cheap prices.

★ What is the Magic Formula?

The Magic Formula is a stock screening strategy created by Joel Greenblatt, described in his book The Little Book That Beats the Market. The idea is straightforward: consistently buy good businesses at cheap prices, and you should outperform the market over time.

The formula ranks every stock in the market on two criteria and combines those ranks into a single score:

Earnings Yield EBIT ÷ Enterprise Value — how cheap is the stock relative to its earning power?
Return on Capital EBIT ÷ (Net Working Capital + Net Fixed Assets) — how efficiently does the company generate profits?

A stock that ranks in the top 50 on earnings yield and return on capital is both cheap and high-quality — the combination Greenblatt calls the “Magic Formula.” The strategy calls for buying a diversified portfolio of these top-ranked stocks and holding them for a year before reconsidering.

Over many years of back-testing, the formula has consistently outperformed the S&P 500, though like any strategy, it can lag the market for extended periods.

🔍 What MagicDiligence Adds

The Magic Formula screen is entirely quantitative — it knows nothing about why a stock is cheap or whether earnings are sustainable. Sometimes a stock ranks highly because it is genuinely undervalued; other times it is a value trap.

MagicDiligence takes the top 50 Magic Formula stocks with a market capitalisation above $250 million and runs each one through an AI-assisted due diligence review, checking for four key red flags that often explain why an otherwise attractive stock should be avoided:

Each stock receives a simple Pass or Fail verdict. A Pass does not mean “buy this stock” — it means none of the four red flags were raised and the stock is worth researching further. A Fail means at least one concern was identified, and more caution is warranted.

🚩 The Four Red Flags

These are the specific checks performed on every stock in the screener:

Non-Recurring Revenue

One-time gains, contract windfalls, divestitures, or other events that inflate earnings without reflecting sustainable business performance.

Fraud & Short-Seller Allegations

Active SEC investigations, accounting restatements, short-seller reports alleging fraud, or other credible evidence of corporate misconduct.

Financial Health Risks

Concerning debt levels, liquidity issues, covenant violations, going-concern disclosures, or other balance sheet factors that put earnings at risk.

Peak-Cycle Earnings

Companies in highly cyclical industries — shipping, commodities, defense — whose current earnings may reflect a cycle peak rather than normalized profitability.

📋 How to Read the Results

The screener displays every stock with its Magic Formula rank (lower is better) and a due diligence verdict:

✓ Pass — None of the four red flags were raised. The stock is worth researching further.
✗ Fail — At least one red flag was identified. Proceed with extra caution.

Click any ticker to read the full due diligence report, which explains exactly what was found (or not found) for each of the four checks.

A Pass is not a buy recommendation. It simply means no red flags were found by the automated review. Always do your own research before making any investment decision.

ℹ Important Notes