The Many Flavours of Value Investing
"Buy a dollar for fifty cents." That's the essence of Value Investing. But how you find that fifty-cent dollar is where opinions diverge. Over the years, several sub-strategies have emerged. In this article, we put the three most popular side by side: Deep Value, GARP, and the Magic Formula. Who is the ultimate winner?
1. Deep Value (Cigar Butt Investing)
This is the classic method devised by Benjamin Graham (Warren Buffett's mentor). For a head-to-head comparison of the Magic Formula with Buffett's own approach, see our Magic Formula vs. Warren Buffett breakdown.
- How it works: You search for companies so cheap that their market value is below the liquidation value (assets minus liabilities).
- In practice: You often buy companies with serious problems. Warren Buffett called these "cigar butts" on the street: dirty, but there's still one free puff left.
- Risk: The dreaded Value Trap — companies that look cheap but simply go bankrupt.
2. GARP (Growth at a Reasonable Price)
Popularised by legendary investor Peter Lynch. It's a hybrid between growth and value investing.
- How it works: You seek companies with strong growth prospects, but refuse to pay the absurd valuations typical of pure growth stocks.
- In practice: Investors often look at the PEG ratio (Price/Earnings-to-Growth).
- Risk: Growth expectations are predictions. When growth disappoints, prices collapse hard.
3. The Magic Formula
Joel Greenblatt's quantitative approach.
- How it works: A strict ranking based on return on capital (quality) and earnings yield (price).
- In practice: A purely mechanical system. You buy the top 30 stocks, hold them for a year, and rotate.
- Risk: Emotionally demanding. The formula often buys companies that are being punished hard in the news.
The Ranking: Which Strategy Fits You?
| Ranking | Strategy | Difficulty | Time Required | Ideal For |
|---|---|---|---|---|
| #1 | Magic Formula | Low (mechanical) | Low (a few times a year) | The data-driven, disciplined investor |
| #2 | GARP | Medium | Medium | The investor who wants the best of both worlds |
| #3 | Deep Value | High (lots of analysis) | High | The experienced numbers nerd with a strong stomach |
Conclusion: Who Wins?
When we look purely at accessibility and historical mathematical evidence, the Magic Formula wins. It doesn't require the deep accounting knowledge of Deep Value, and avoids the guesswork about the future required by GARP.
You do, however, need the robot-like discipline to keep following the formula — precisely when the selected stocks are having a hard time. That discipline, as it turns out, is far rarer than any financial skill.
Want to learn exactly how the Magic Formula works? Start with our 5-minute beginner's guide. And to understand why discipline is so difficult, explore the psychology behind Magic Formula investing.
