1. Most people and businesses can’t find investments that will earn very high rates of return. A company that can earn a high return on capital is therefore very special.
2. Companies that earn a high return on capital may also have the opportunity to invest some or all of their profits at a high rate of return. This opportunity is very valuable. It can contribute to a high rate of earnings growth.
3. Companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above- average profits.
4. By eliminating companies that earn ordinary or poor returns on capital, the magic formula starts with a group of companies that have a high return on capital. It then tries to buy these above-average companies at below-average prices.
5. Since the magic formula makes overwhelming sense, we should be able to stick with it during good times and bad.