6 ideas
Rank all companies above a size cutoff by return on capital and separately by earnings yield, then add the two ranks and buy the companies with the best combined score. Hold 20–30 of them, sell each after about a year, and replace them with the current top-ranked names. The method mechanically selects good businesses at bargain prices and removes the investor's judgment from selection.
Return on capital is defined as EBIT divided by net working capital plus net fixed assets, the tangible capital actually needed to run the business. A company that earns a high return on this capital can reinvest its profits at high rates or return cash to owners. That makes it a better business than one that needs heavy capital to produce the same earnings.
Earnings yield is EBIT divided by enterprise value (market capitalization plus net debt). It shows what the business earns relative to the full price of buying it, debt included.
Greenblatt values stocks through Jason, a kid who sells gum at school. He asks how much Jason's business earns, what it would cost to buy, and whether that beats putting money in a bank. Stripping a stock down to a small, concrete business shows that a share is a claim on real earnings, and its worth depends on those earnings relative to the price paid.
A stock's true value is set by the future cash its business will produce, and that changes slowly. Market prices swing widely because of fear and greed. Seen this way, volatility is not risk to fear but an opportunity to buy when a moody seller offers a price far below value.
The formula can underperform the market for one, two, or even three years in a row. Most investors abandon it during those stretches and chase whatever has recently worked. That behavioral cost is what keeps the edge from being arbitraged away, so the returns go only to those disciplined enough to stick with it through losing periods.