The Little Book That Beats The Market is the first book in Little Books, Big Profits series. Does the book have in it to beat the market? Is it really worth a read? The real question is whether a small sized book can give you insights about the stock market, amidst all the popular investment books out there in the market? Let’s find out.
The book is written by a well-known investor named Joel Greenblatt. It consists of a total of thirteen chapters, which are broadly written in a format of a story, making it easier for people – who don’t know anything about the stock market – easier to understand.
The book starts off by telling you that professionals can’t help you in beating the market, you must go on your own. The first chapter is where the author starts telling a story of a boy selling bubble gum. The author and his son try to come up with a value for the boy’s bubble gum business, giving an insight into valuing companies listed on the stock market.
The author gives us an idea about the risk-free rate and also gives some options where we can invest money and tells us why investing in the stock market is your best option if you are investing for the longer term. He further tells us that owning a stock is just like owning a piece of business.
Greenblatt offers the same notion of Mr. Market and Margin of Safety which Graham used in his book, The Intelligent Investor, along with using examples, which makes it easier to understand. All the chapters till here will help you to get a basic understanding of how the stock market works.
Now comes the most important part of the book, the magic formula. It revolves around two parameters, earnings yield, inverse of a P/E ratio, and return on capital, which is the amount earned by the business as compared to the total money put into the business. All this is explained in a beautiful way using the same business of bubble gum.
What we need is a higher earnings yield and a higher return on capital. In other words, you should be buying quality businesses (higher return on capital) at a cheaper price (low P/E or higher earnings yield). This, in essence, is what value investing is all about, and what Warren Buffett has been following since the past 50+ years.
However, this magic formula isn’t something which will be beating the market every year. Rather, it will help you beat the market over the longer term, but, there will be some periods where you fail to beat the market. If you’re actually willing to stick with it over several years, through thick and thin, then it will pay off for you. If you’re not willing to do that and just let it ride, then this investing concept won’t necessarily work.
The book concludes by going into the concept of index investing, stating that most investors are better off investing in index funds instead of individual stock picking as broad-based index will do well over time and is less volatile than individual stock picking.
Finally, the appendix will tell you how you can go on applying the magic formula. A way you can do this can be like this:
Go to a website that lets you filter stocks (like Screener). You can also find a ready-made screen of magic formula. Or you could also make your own screen by applying a filter of ROA > 15 percent and sort the stocks according to P/E, with the lowest P/E stock at the top.
The Little Book That Beats The Market is a great book to get yourself introduced to the stock markets and understand how stock markets work. If you are looking for a thorough investing guide, or have a basic idea about how the stock market works, then this book is not for you.
On the other hand, if you are starting out, and have no idea where to start, this book is a great way to get you started in the stock market. In other words, read this book if you’re thinking about investing in individual stocks, but don’t know where to start.