Wednesday, July 29, 2009

Book review: The little book that beats the market by Joel Greenblatt

The little book that beats the market – Joel Greenblatt

This book explains an extremely simple strategy that the author suggests will beat the market return. The author starts by telling a story of a boy who sells packs of gum. The story explains in very simple terms, how to correctly value a business. From the first chapter onwards, the author uses very simple story-telling to explain finance concepts and principles. Each chapter adds to the previous ones and becomes more complex and detailed. All this storytelling is used to give the reader an understanding of why the author’s ‘Magic Formula’ works in beating the market.
The ‘Magic Formula’ is a very simple concept in finance but the author holds that it has beaten the market returns from the past 17 years and there is little reason why it will not continue to do so. Towards the end of the book the formula is explained in detail with enough information for the average investor to apply it. The appendix is full of detailed information on the formula.

What I gained from reading this book:
I picked up this book with great scepticism. My finance lecturers told me that people cannot consistently beat the market (the Efficient Market Hypothesis). I decided to give it a read. The way the book is written is very unusual for an investment book. The best way to describe it would be that it was written for a young teenager. No jargon or excessive words. The author doesn’t take himself too seriously by adding little jokes throughout the book. All in all it was an interesting read.
With the actual ‘Magic Formula’, the author does a fantastic job in convincing the reader that the strategy is solid and will continue to give fantastic results in the future. As this book was written in late 2005, we have the ability to see how it has performed since then. After some research I have found quite a few blogs and website where people report their results using the ‘magic formula’. Some people have had poor results as it underperformed while others have held that it has been outperforming the market. At the moment I am doing my own testing but I think it is still too soon to say whether it will continue to show impressive results or not. My instincts tell me this is another ‘too good to be true’, but on the other hand, I wouldn’t be surprised if it does consistently outperform the market because of the logic behind the strategy.
I will continue to study this method and will report back if I come to any conclusion.

Well written and easy to understand whether you have a background in finance or not. Important explanations on value, price and earnings. Very convincing explanations and results.

May not continue to outperform the market in the future. Seems a bit too good to be true.
Recommended for: Investors
Anybody who is interested in investing in the share market should have a read of this book. Even if you don’t choose to invest by using the method in the book, the explanations on finance concepts are easy enough for a child to grasp.

Genre: Investments

Overall rating: 8 out of 10 stars

Australians can buy the book by clicking the picture below:
The Little Book That Beats the Market (Little Books, Big Profits)

Where to from here:
More detailed books on investing that I recommend are:
The four pillars of investing – William Bernstein
Five key lessons from money managers – Scott Kays

If you have read this book, feel free to give it your own rating by posting a comment below. If you have invested following this method, please let me know how it has gone for you.

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