In this article, we will take a look at the 10 Best Magic Formula Stocks for 2025.
The Magic Formula, as defined by Joel Greenblatt in his book The Little Book that Beats the Market, entails evaluating companies based on two metrics: earnings yield (EBIT/enterprise value) and return on capital. Greenblatt is one of the few fund managers who have regularly achieved double-digit percentage returns during their careers on Wall Street. His former business, Gotham Capital, had an incredible run from 1985 until 1994. During this time, the fund generated a net return of 34%. That said, even he was conscious that this method seemed too wonderful and easy to be true, which is why, throughout his book, he frequently questions the reader: what is the assurance, if any, that this investment technique genuinely works and is not just a fluke? In any case, he frequently underlines that the Magic Formula investment technique does not encourage investing in firms with average or low return on capital since the strategy creates a rating system to identify top companies with the best return on capital and earnings yield.
However, like with any method, there is some risk involved, and the Magic Formula does not ensure success. Since the strategy is based on past data, it’d be difficult to say if it could work well in the future, especially if market conditions change. Incidentally, a backtest of market performance from 2003 to 2015 found that the Magic Formula approach produced annualized returns of 11.4%, while the S&P 500 produced returns of 8.7%, thus failing to live up to Greenblatt’s inflated claims despite beating the benchmark. Greenblatt himself admits that the Magic Formula fails in many cases and performs poorly in some others, particularly when the holding time is too short. The investor stated the following:
“Most people just won’t wait that long. Their investment time horizon is too short. If a strategy works in the long run (meaning it sometimes takes three, four, or even five years to show its stuff), most people won’t stick with it. After a year or two of performing worse than the market averages (or earning lower returns than their friends), most people look for a new strategy— usually one that has done well over the past few years. Even professional money managers who believe their strategy will work over the long term have a hard time sticking with it.”
More recently, however, Joel Greenblatt’s fund appears to have lagged behind the overall market as a result of his investment strategy. As of the end of January, the Gotham Large Value Fund (GVALX) has only returned 10.86% over the last five years, while the S&P 500 has returned 15.17%. Nonetheless, the Magic Formula is one of many investment strategies that investors can opt for as they navigate the stock market.
Joel Greenblatt of Gotham Asset Management
Our Methodology
To make our list of the best Magic Formula stocks, we ranked the stocks in Gotham Asset Management’s Q4 2024 SEC filings by their stake value and picked out the most valuable holdings.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 373.4% since May 2014, beating its benchmark by 218 percentage points (see more details here).
10. Berkshire Hathaway Inc. (NYSE:BRK-A)
Number of Hedge Fund Holders: 131
Gotham Asset Management’s Q4 2024 Stake: $35.7 million
Berkshire Hathaway Inc. (NYSE:BRK-A) is a diversified global conglomerate holding corporation focused mostly on the insurance industry. It invests cash earned by insurance activities in a diverse range of subsidiaries, stock holdings, and securities from numerous sectors.
On January 24, UBS analyst Brian Meredith raised Berkshire Hathaway’s price target to $803,444 from $796,021, while keeping a Buy rating on the stock. The change comes as UBS integrates the anticipated impact of the Los Angeles flames into its predictions. Berkshire Hathaway’s reinsurance branch is expected to suffer an insured loss of $1 billion, while the impact on its basic insurance operations is expected to be less significant at $150 million. Meredith’s forecast for Berkshire Hathaway Inc. (NYSE:BRK-A) includes a modest increase in the 2026 earnings per share projection.
Berkshire Hathaway Inc. (NYSE:BRK-A) reported a significant increase in Q4 2024 earnings, owing mostly to its insurance firms, while cash holdings hit a record high. The company’s operational profit climbed by 71% to $14.53 billion during the quarter. This growth was fueled by a 302% rise in insurance underwriting profits, which reached $3.41 billion, and a roughly 50% increase in insurance investment income, which totaled $4.09 billion.
9. Merck & Co., Inc. (NYSE:MRK)
Number of Hedge Fund Holders: 91
Gotham Asset Management’s Q4 2024 Stake: $42.28 million
Merck & Co., Inc. (NYSE:MRK) is a prominent American multinational pharmaceutical corporation that is historically tied to the original Merck Group. Internationally known as Merck Sharp & Dohme (MSD), the company provides prescription pharmaceuticals, vaccines, biologic treatments, and animal health products.
Additionally, Merck & Co., Inc. (NYSE:MRK) started a significant Phase 3 clinical trial for Zilovertamab Vedotin in late 2024, an investigational drug designed to treat patients with diffuse large B-cell lymphoma. This stage comes after positive Phase 2 trial findings and aims to demonstrate the benefits of the new combination regimen.
On February 10, Bernstein SocGen Group reduced its price target for Merck & Co., Inc. (NYSE:MRK) shares to $95 from $110, while maintaining a Market Perform rating. Analyst Courtney Breen mentioned concerns about Gardasil, Merck’s vaccine, which is nearing the end of its exclusivity period (LOE), as a crucial component in the adjustment. Despite Merck’s Q4 profitability, lingering Gardasil worries have harmed the stock’s performance. Breen acknowledges that the lower end of the Gardasil sales prediction has been de-risked, with $200 million in sales from China now realized, and that this move has been included in Bernstein SocGen’s base case scenario.
GreensKeeper Asset Management stated the following regarding Merck & Co., Inc. (NYSE:MRK) in its Q3 2024 investor letter:
“Merck & Co., Inc. (NYSE:MRK) was our second-largest detractor this quarter, declining -8.3%. MRK’s leading HPV vaccine, GARDASIL 9, faced challenges internationally due to inventory buildup within its Chinese distributor, which is expected to reduce shipments for the remainder of 2024. Despite this short-term impact, the long-term outlook for GARDASIL 9 remains promising. Meanwhile, the company’s $27 billion Keytruda cancer juggernaut continues to grow at a healthy clip, powering earnings growth.”