What Is the Magic Formula?

The Magic Formula is a rules-based stock-screening approach developed by hedge fund manager Joel Greenblatt and described in his book The Little Book That Still Beats the Market. The strategy is designed to systematically identify high-quality companies trading at attractive prices—combining two key financial ratios into a single composite rank:

• Return on Invested Capital (ROIC) — measures how efficiently a company generates profit from its invested capital, serving as a proxy for business quality.
• Earnings Yield — calculated as EBIT divided by enterprise value, this is the inverse of the EV/EBIT multiple and serves as a proxy for valuation attractiveness.

Each stock in a universe is ranked separately on both metrics, and the ranks are combined. A lower combined Magic Formula (MF) Rank generally signals a company that is both high-quality and relatively cheap. The strategy is entirely quantitative: no subjective judgments about management or industry outlook are applied.

ServiceNow, Inc. (NYSE:NOW) — Key Screening Metrics

Magic Formula Rank

At the time of writing, ServiceNow carried an MF Rank of 11,585. Within a large screening universe, this is a relatively high (unfavorable) rank, reflecting that the stock scored poorly on one or both of ROIC and earnings yield relative to peers. This is consistent with ServiceNow’s profile as a high-growth SaaS company that typically trades at a significant premium to earnings.

Value Composite Scores (VC1 and VC2)

Developed by James O’Shaughnessy, the Value Composite 1 (VC1) score aggregates five valuation ratios into a single 1–100 scale:

• Price to Earnings (P/E)
• Price to Cash Flow (P/CF)
• Price to Book Value (P/B)
• Price to Sales (P/S)
• EBITDA to Enterprise Value (EBITDA/EV)

A score near 0 indicates a relatively undervalued company; a score near 100 indicates a relatively overvalued company. ServiceNow’s VC1 was 80, suggesting the market was pricing it at a significant premium versus the broader screening universe. Adding a sixth factor—shareholder yield—produces the Value Composite 2 (VC2), which stood at 82 for NOW, marginally reinforcing the overvalued reading.

Traditional Valuation Ratios

The individual ratios feeding into the composite scores for ServiceNow were:

The extremely elevated P/E ratio is characteristic of high-growth technology companies reinvesting heavily, where GAAP net income is compressed by stock-based compensation and other non-cash charges. Investors relying solely on P/E to assess valuation in this context should use it alongside cash-flow-based metrics.

Q.i. Value

The Q.i. Value ranks companies on four factors designed to surface the most undervalued names: EBITDA Yield, Free Cash Flow (FCF) Yield, Liquidity, and Earnings Yield. Lower scores indicate greater undervaluation. ServiceNow’s Q.i. Value was 55, placing it in the middle of the distribution—neither clearly undervalued nor severely overvalued on this combined measure.

Piotroski F-Score

Developed by Stanford accounting professor Joseph Piotroski, the F-Score uses nine binary tests drawn from a company’s financial statements to assess financial strength. One point is awarded for each test passed:

• Profitability signals: positive ROA, positive operating cash flow, improving ROA, accruals (cash flow exceeds net income)
• Leverage and liquidity signals: decreasing long-term debt ratio, improving current ratio, no new share dilution
• Operating efficiency signals: improving gross margin, improving asset turnover

Scores of 8–9 are considered strong; scores of 0–2 are considered weak. ServiceNow scored 6, indicating a reasonably healthy but not exceptional financial position by these criteria.

Gross Margin Score

The Gross Margin score (based on the Marx methodology) evaluates gross margin stability and growth over the prior eight years on a 1–100 scale, where 1 is most positive and 100 is most negative. ServiceNow’s score of 8 indicates consistently strong and stable gross margins—a positive signal for a SaaS business model.

Shareholder Yield

Shareholder Yield measures the total return of capital to shareholders through dividends, share buybacks, and net debt reduction. ServiceNow’s Shareholder Yield was -0.050, and the Mebane Faber variant (which also incorporates net debt repayment yield) was -0.059. Negative values indicate the company was a net issuer of shares or debt—common for fast-growing technology firms funding expansion.

Historical Volatility

Historical volatility figures for NOW at the time of publication:

Historical volatility is calculated from the annualized standard deviation of log-normal price returns over the respective window. Higher volatility means wider price swings and, generally, higher risk—though it can also reflect high investor interest and rapid fundamental change.

Price Index

The price index divides the current share price by the price at a prior point in time. A value above 1.0 indicates price appreciation; below 1.0 indicates a price decline over that window.

The data suggests that despite some near-term softness (1-month and 3-month indices below 1.0), ServiceNow had delivered substantial long-term price appreciation over the prior two and three years at the time of measurement.

DuPont de Nemours, Inc. (NYSE:DD) — Key Screening Metrics

Magic Formula Rank

DuPont de Nemours carried an MF Rank of 403 at the time of writing. This is a substantially more favorable rank than ServiceNow’s 11,585, indicating that DuPont screened as relatively high-quality and attractively priced on the combined ROIC and earnings yield ranking within the universe.

Value Composite Scores

DuPont’s valuation scores paint a very different picture from ServiceNow’s:

• VC1: 21 — suggesting the stock was trading at a relative discount to the broader universe across the five core valuation ratios.
• VC2: 14 — adding shareholder yield further improved the composite score, indicating DuPont was returning capital to shareholders while also trading cheaply on traditional metrics.

Q.i. Value

DuPont’s Q.i. Value was 15, indicating that on the combined EBITDA Yield, FCF Yield, Liquidity, and Earnings Yield measures, the stock screened as significantly undervalued relative to the broader market.

Piotroski F-Score

DuPont’s F-Score was 5 at the time of the analysis—in the middle of the 0–9 range, indicating neither a clearly deteriorating nor particularly robust financial picture by Piotroski’s nine-factor framework.

Gross Margin Score

DuPont’s Gross Margin score was 5, indicating strong and relatively stable gross margin performance over the prior eight years—a positive indicator on the 1-to-100 scale where lower scores are more favorable.

Historical Volatility

DuPont showed notably higher volatility than ServiceNow across all measured windows, likely reflecting the complexity of its recent corporate restructuring:

The 6-month volatility exceeding the 12-month figure suggests a period of particularly elevated price swings in the nearer term. The 12-month volatility figure for DuPont (48%) was also higher than ServiceNow’s (38%), despite DuPont being classified as an industrial/materials company rather than high-growth SaaS.

Return on Invested Capital (ROIC)

ROIC is central to the Magic Formula’s quality assessment. Key ROIC metrics for DuPont at the time of publication:

The gap between the current ROIC (0.62) and the 5-year average (0.12) is notable, and may reflect the impact of the DowDuPont merger and subsequent spinoffs on reported capital figures. The ROIC Quality ratio—calculated by dividing the 5-year average ROIC by its standard deviation—of 3.18 suggests relatively consistent capital returns over time, though interpreting this in the context of major corporate restructuring requires care.

Return on Assets (ROA)

DuPont’s Return on Assets was 0.005 (approximately 0.5%), calculated as net income after tax divided by total assets. This low figure reflects compressed net margins common during periods of restructuring and integration costs. A higher ROA generally indicates more efficient asset utilization.

Understanding the Metrics: A Quick Reference

For readers less familiar with these quantitative screening tools, here is a brief summary of each metric discussed above:

Putting It Together: What the Numbers Say

Comparing the two companies purely through the lens of these quantitative screens in August 2019:

• ServiceNow (NOW) appeared expensive on almost every traditional valuation metric, consistent with its high-growth SaaS profile. Its MF Rank was unfavorable, though its Gross Margin score was strong, indicating durable unit economics. Long-term price momentum was robust.
• DuPont (DD) screened as significantly cheaper—low VC1, VC2, and Q.i. Value—and carried a much more favorable MF Rank, suggesting greater appeal for value-oriented quantitative strategies. However, its elevated volatility and low ROA at the time reflected ongoing post-merger integration complexity.

Quantitative screens are most useful as a starting point for further fundamental analysis, not as stand-alone buy or sell signals. Factors such as industry dynamics, management quality, competitive positioning, and macroeconomic conditions are not captured by these metrics but remain essential to any complete investment thesis.

This article is for informational and educational purposes only. All data reflects figures available at time of original publication (August 2019) and is not current. Nothing here constitutes investment advice.