The whole system around Magic Formula PRO can be summarized in two quotes by two legendary investors.

“If only one word is to be used to describe what Baupost does, that word should be: ‘Mispricing’. We look for mispricing due to over-reaction.” -Seth Klarman

“We don’t have to be smarter than the rest. We have to be more disciplined than the rest.” -Warren Buffett

While value investing is simple, it’s definitely not easy. There will be times when the magic formula doesn’t produce returns or great bargains for quite some time. Other times, like in March of 2008, we will find plenty of amazing businesses selling at bargain prices. But, at the same time, in order to take advantage of those bargains, we have to pass on about 95% of the stocks that the magic formula turns up. and swing big for the one’s which we believe are amazing bargains.

Other than being patient and waiting for mispriced opportunities, the other key to success is sticking with the system.  There are many ways to outperform the market using value based ratios such as low P/E, low P/BV, low P/CF to name a few. But, all the research in the world will not matter if you do not stick with the system. The whole magic formula system is based on finding great businesses at bargain prices. There aren’t too many people who will disagree that buying great business at bargain prices is a bad strategy to follow. But as Joel Greenblatt continuously reminds us throughout the little books and the various media appearances, the magic formula works because it doesn’t work all the time.