Green Card

A Green Card, in the investment world, has nothing to do with immigration. It's a playful term coined by famed investor and professor Joel Greenblatt for the list of stocks generated by his quantitative investment strategy, Magic Formula Investing. This strategy, detailed in his bestseller “The Little Book That Beats the Market,” provides a simple, systematic way for investors to find what value investing patriarch Benjamin Graham described as “wonderful companies at fair prices.” The “Green Card” is essentially a pre-vetted shopping list of companies that rank highly on two key metrics: they are both high-quality (meaning they earn a high return on the money they invest in their business) and cheap (meaning they are available at a low price relative to their earnings). By focusing on these two simple but powerful concepts, the strategy aims to remove emotion from the investment process and consistently buy above-average companies at below-average prices.

The Green Card list is the final output of a two-part screening process that ranks stocks based on their quality and their price. Greenblatt's genius was in finding simple, effective proxies for these two attributes.

How do you measure a “good” or “quality” business? Greenblatt argues it's one that can invest its capital and generate a high rate of return. A bakery that spends €10,000 on a new oven and generates an extra €5,000 in profit each year is a much better business than one that generates only €500. To capture this, the formula uses Return on Capital (ROC).

• What it is: ROC measures how much profit a company generates for each dollar of capital it employs in its operations.
• The Formula: While there are many variations, Greenblatt's specific formula is: EBIT / (Net Working Capital + Net Fixed Assets).
• Why it matters: A high ROC suggests the company has a durable competitive advantage—a “moat”—that allows it to earn outsized profits. These are the efficient, high-quality businesses we want to own.

Finding a great business is only half the battle; you must avoid overpaying for it. To find “cheap” stocks, the formula uses Earnings Yield. This is simply the inverse of the popular but often misleading P/E Ratio.

• What it is: Earnings Yield tells you how much operating profit the business is generating relative to its total value (including both stock and debt).
• The Formula: Greenblatt's version is: EBIT / Enterprise Value.
• Why it matters: A high earnings yield means you are getting a lot of profit-generating power for the price you pay. It's like choosing between two identical bakeries, but one is on sale for half the price of the other. You're getting more “bang for your buck.”

The Magic Formula is not about finding a single “golden ticket” stock. It is a portfolio strategy that relies on discipline and a long-term mindset. Greenblatt's website automates the process, but the steps are straightforward:

1. 1. Establish a Universe: Start with a broad list of stocks, excluding utilities, financial companies (as the formulas don't apply well to them), and very small companies.
2. 2. Rank for Quality: Calculate the Return on Capital for every company and rank them from best (1st) to worst.
3. 3. Rank for Price: Calculate the Earnings Yield for every company and rank them separately, again from best (1st) to worst.
4. 4. Combine the Ranks: Add the two ranks together for each company. A company that ranked 10th on ROC and 25th on Earnings Yield would get a combined score of 35.
5. 5. Buy a Basket: Re-rank the companies based on their combined score (the lower, the better). Purchase a diversified basket of the top 20 to 30 stocks.
6. 6. Hold, Sell, Repeat: Hold the stocks for one year. After a year, sell them and repeat the entire process, replacing the old list with the new “Green Card” stocks. This disciplined rebalancing is critical for tax efficiency and for ensuring the portfolio stays true to the strategy.

The Green Card strategy is a powerful embodiment of quantitative value investing. It systematically enforces the discipline that many investors lack.

• The Pros: Its greatest strength is its simplicity and its ability to counteract our worst behavioral biases, like fear and greed. By automating the “buy good and cheap” mantra, it forces you to look at companies that may be temporarily out of favor but are statistically attractive.
• The Cons: The main drawback is that it can, and often does, underperform the market for multi-year stretches. This tests an investor's patience to its limit, causing many to abandon the strategy at the worst possible time. Furthermore, it is a purely quantitative screen. It knows the numbers but not the story, so it can't tell you why a company is cheap. A cheap stock might be a true bargain or it might be a “value trap” on its way to bankruptcy.

The “Green Card” is an excellent tool for idea generation and a fantastic starting point for any serious value investor. It provides a disciplined, data-driven list of potentially undervalued, high-quality companies. While some investors follow the formula blindly, many use the list as a hunting ground for further, deeper research. At its core, the Magic Formula is a powerful reminder that a simple, logical process, followed with unwavering discipline over the long term, is one of the surest paths to investment success.