The magic formula combines cheapness and quality into a single ranking

Greenblatt's core mechanism ranks every eligible stock twice: once by earnings yield, which measures how much a company earns relative to its market price (a higher yield meaning the stock is cheaper relative to its earnings), and once by return on capital, which measures how efficiently a company generates profit from the capital invested in its operations (a higher return meaning a more efficient, higher-quality business). Each stock gets a combined score from adding its two rankings together, and the formula recommends buying the stocks that rank best on both measures simultaneously — companies that are both statistically cheap and genuinely good businesses, rather than cheap because they're mediocre or expensive because they're excellent. This dual filter is the innovation: buying purely cheap stocks alone can mean buying troubled companies deservedly out of favor, while buying purely high-quality companies alone often means overpaying, and the formula tries to find the overlap where both conditions hold at once. Takeaway: the best opportunities aren't just cheap or just good — they're both at the same time, and a formula can find that overlap systematically.