A Global Strategy or an American Phenomenon?

Joel Greenblatt's original backtests, as outlined in his books, were conducted exclusively on the US stock market. Because of this, many international investors wonder: Will the Magic Formula work on the Euronext, the London Stock Exchange, or the German Xetra?

The short answer is: Yes, absolutely. In fact, data suggests it might sometimes work even better outside the US. Here is what you need to know about applying the strategy in Europe.

What the Academic Backtests Say

Since the book's publication, numerous independent analysts and university researchers have backtested the formula on European and global markets.

  • Studies focusing on the Nordic region (Sweden, Norway, etc.) have historically shown strong outperformance.
  • Backtests on the broader European market generally show that the strategy beats local indexes (like the Stoxx Europe 600) over long periods.

Why does it work so well in Europe? The European market is generally less "efficient" and receives less analyst coverage compared to the hyper-analysed US market — especially in the small to mid-cap space. This leaves more mispriced stocks for the Magic Formula to exploit.

Key Differences When Investing in Europe

While the math works, the implementation requires some adjustments.

1. The Screener Problem

The official Magic Formula website only provides US stocks. To find European stocks, you must use a premium third-party screener that supports European exchanges. We compare all the best options in our guide to Magic Formula screeners.

2. Accounting Differences (IFRS vs. US GAAP)

European companies report under IFRS (International Financial Reporting Standards), while US companies use US GAAP. While screeners usually normalise this data, it's good to know that metrics like EBIT (used in the formula) might be calculated slightly differently. Our deep dive into Earnings Yield and Return on Capital explains exactly how these metrics are defined.

3. Lower Liquidity

Many European stock exchanges have lower trading volumes than the US. If the screener selects a micro-cap stock in a smaller European country, you might face wide bid-ask spreads. It is highly recommended to set a minimum market cap of at least €50 million to €100 million to ensure enough liquidity.

Conclusion

The fundamental premise of the Magic Formula — buying good companies at cheap prices — is a universal truth of investing. It works just as well in London or Frankfurt as it does in New York. However, to execute it successfully in Europe, you will need to invest in a premium global stock screener and pay close attention to the liquidity of the stocks you buy.

European investors should also consider the tax implications of annual portfolio turnover. Our tax-smart investing guide covers country-specific strategies for keeping more of your returns.