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A Look at Magic Formula Investing
By JLP | January 4, 2007
I read Joel Greenblatt’s The Little Book That Beats The Market
Fortunately, Greenblatt has a website called MagicFormulaInvesting.com that will list the stocks that meet the criteria. So, I thought I would try it out.
I went to MagicFormulaInvesting.com and entered the following information:
After entering that information, I hit the “Go” button, which took me to a sign-in page where it asked me for my email address and password. After signing in, I was taken to the final page, which offered the following results:
The note at the bottom of the printout says the following:
Note: See The Little Book That Beats The Market
The printout isn’t all that useful since the results are in alphabetical order rather than a ranked order. So, I ranked them by their pre-tax earnings yields:
As the note above states, I highlighted the top 5 in dark grey (and the next two to bring the total to 7 are highlighted in lighter grey).
I thought it would be fun for us to follow this strategy for a year or two to see how it works. So, I’m going to set up a hypothetical account with FOLIOfn and “purchase” the first 5 stocks in the above list. Then in early March, I’ll run the screen again and “purchase” 5 more from that list. I’ll continue purchase stocks every two months until there are 20 stocks in the portfolio. Finally, in January I’ll sell the first batch of stocks and replace them with stocks from another new screen.
It should be fun.
Topics: Investing |
January 5th, 2007 at 2:11 am
If you’re interested I’ve been making real trades since July to create a “little book” portfolio and provide updated details of my actual trades and performance each month in my blog. I buy about $5000 worth of 1 stock each month, and will hold each one for 18 months before selling it and buying a replacement stock. (The reason I’ve varied a bit from Greenblatt’s exact methodology is that as an Australian investor, direct investment in US stocks is a bit expensive (each trade cost $65!) so I had to minimise trading costs by extending the holding period.
I’ve been picking my stocks the same way as you’ve ranked them, but I’ve avoided mining stocks as I think there is a risk of commodity prices dropping within my holding period, so they could go from being “value” to “overpriced” very quickly.
Regards
http://enoughwealth.blogspot.com
January 5th, 2007 at 3:42 am
This will be interesting to watch. Kudos.
Are there contrarians to efficient market theory that apply rigorous tools in their debate? If you have come across other credible challenges to it, please do post them. I find EMT very persuasive, and missing a credible opposing perspective. I’d like to weigh both sides if possible.
January 5th, 2007 at 3:43 pm
I actually set up a theoretical 20 stock portfolio from this web site last year and it did very well - $40,000 (again, just theoretical) turned into over $51,000. If I knew how I would post the entire portfolio for you to see, but some of the big movers were:
AEOS: 118%
HOC: 74%
MVL and NUE: 61%
BSX: (32%)
CECO: (23%)
DLX: (13%)
January 5th, 2007 at 3:45 pm
Oh, and that doesn’t include dividends.
January 5th, 2007 at 6:27 pm
@Enoughwealth
Being an Australian investor as well, I know what you’re talking about. However, have a look at optionsxpress. They have pretty competitive rates for US trading (compared to Australian brokerages but no where near the rates the US market gets) and if you open an Australian account with them, you can transfer cash from your Australian brokerage account to your US brokerage account without any charges (which is another huge advantage). The only drawback is the time it takes to transfer money over (which shouldn’t matter for investing as opposed to trading) and the form you need to fill + send every time you need a transfer.
Cheers
G
January 5th, 2007 at 7:54 pm
Hmm,I am not so sure about these investing formulas. There is always a qualitative aspect of investing that these techniques do not appreciate. The results will be interesting! I bet they rise if the market rises and fall if the market falls. perhaps compare them with others in their sector. I look forward your march update.
young
January 7th, 2007 at 1:38 am
I’m very glad you’re doing this. I noticed that book a few months ago, read through it a little bit, and wondered how well it would actually work. I guess we’ll see!
It seems it already worked well in Rob’s test!
January 8th, 2007 at 4:34 pm
Hi,
I believe the results of Greenblatts’ MF-screen won’t be that good in the coming years. This because of the (unexpected) rise of commodity prices in the last years. These have led to high ROIC’s and EY’s for these kind of companies, which make them likely candidates in the screening process.
Because of the lack of (durable) competitive advantages, their returns won’t be that good, and will drag down the returns of the whole MF-selection,
Hendrik Oude Nijhuis
http://www.magicformulastocks.com
January 9th, 2007 at 9:11 pm
The method requires you to sell the stocks acquired after a one-year holding period — a few days less than a year for losers in taxable accounts, a few days after a year for winners in taxable accounts — and replace them with new stocks.
Greenblatt’s book contains several caveats, not the least of which is that the method doesn’t work in five of every 12 months. If you’re going to try use it, it requires commitment toward a long-term goal and diversification among 20-30 stocks acquired over time. I noticed that one of the top 100 stocks generated on my list was down 18% a day or two ago!
I’m trying it in a small Sharebuilder account, but, like Hendrik, I noticed the list was top-heavy with commodity stocks, providing additional incentive beyond what I already had to select my stocks across several industries.
January 10th, 2007 at 3:22 pm
Hi Diffus,
I agree with you completely. There are many ‘problems’ with the Formula. (Greenblatt also said that but told he wanted to keep things as simple as possible). Personally I think it’s a valuable book (and a nice gift to friends…), but his list is also valuable as a starting screen (for further research).
Success in investing
Hendrik Oude Nijhuis
http://www.magicformulastocks.com
January 11th, 2007 at 8:05 pm
Today was my 1 year anniversary following the magic formula. You can see my blog here: http://magic-formula-investing.blogspot.com
February 9th, 2007 at 10:50 am
[...] Well, a month has gone by since I started the Magic Formula Portfolio, which is based on Joel Greenblatt’s The Little Book That Beats The Market. My goal with this little experiment is to see just how well Greenblatt’s “Magic Formula” works. Here’s how I set up the portfolio: [...]
March 27th, 2007 at 1:03 pm
[...] As discussed in an earlier post, I’m going to follow a hypothetical post using the Magic Formula found in Joel Greenblatt’s The Little Book That Beats The Market. [...]
April 30th, 2007 at 11:08 pm
[...] A Look at Magic Formula Investing [...]
October 5th, 2007 at 11:48 am
[...] A Look at Magic Formula Investing [...]
October 5th, 2007 at 1:51 pm
I’ve seen you post these entries, but I haven’t really paid much attention. Since I’m thinking about broadening my own investments, now I’m interested. I’ll have to go read that particular little book…
October 7th, 2007 at 3:21 am
[...] A Look at Magic Formula Investing [...]
January 2nd, 2008 at 8:20 am
[...] A Look at Magic Formula Investing [...]
January 19th, 2008 at 2:26 am
What I do not fully understand is why these stocks need to be sold after a year (+/- 2 days). I don’t see how this is consistent with the ‘long term’ approach he emphasizes. Especially when investing from abroad this makes it expensive and I am not sure if the alleged tax benefits also apply to foreign investors.
BTW: Are there any comparable databases available for e.g. The Netherlands/Europe? Would be good to set that up; willing to play a role there. Hendrik, would you know ways from your experience?
Kind regards,
Edo Oliemans
March 9th, 2008 at 8:59 pm
Anyone interested in really trying the magic formula should use zecco trading. Its the only free online broker out. As long as you have a $2500 balance you get 10 free trades per month.
Hope this help,
May 12th, 2008 at 11:09 am
[...] [...]
July 4th, 2008 at 11:50 pm
July 5th, 2008
I started to use the MF in 2006 and after getting up to 30% on my first year initial investment of 180K, I am now down to 158K! Not only did I loose all the acquired profits in the last 10 months but I have also lost another 22K on the amount invested!
By the way, if one chooses to invest 5K on 5 stocks each time during the investing period, and then these stoks go down, you’re left with less money to invest when it’s time to re-invest so you end up with less money invested which will affect your portfolio’s ability to come back from its losses.
I guess the MF did not like this 2007-2008 period at all and there is probably more bad stuff to come our way considering that there is still truckloads of CDO’s out there waiting to be cleaned out the closets!
Oil is going up, reserves are going down, food is going up while flooding is up too on the 2008 crops, banks are in bad shape, looks like a big crash in the making of the likes we have not seen in our lifetime!
I guess Georges Soros is on the money with his reflexivity theory, markets do not tend toward equilibrium or at least it’s not as simple as that and that’s where the MF goes down.
I am all cash today and studying hard my next picks!
October 30th, 2008 at 8:55 pm
[...] [...]