By JLP | February 4, 2008
Lily over at TheHonestDollar sent me an email last week alerting me to Fred Frailey’s article on the Magic Formula in the March issue of Kiplinger’s. Fred actually contacted me when he was working on the article but didn’t reference me in the finished product. Anyway, it’s a good article. I already knew that Fred was a fan of the Magic Formula when he mentioned the book and the formula in one of his editor’s columns.
The actual article is not yet available on the Kiplinger’s website but I wanted to go ahead and share with you a couple of interesting quotes from the article. Fred’s purpose of the article was to show how people aren’t following Greenblatt’s formula, which was explained in The Little Book That Beats The Market (Affiliate Link). From the article:
Had you followed Greenblatt’s instructions religiously between 1988 and 2004 by investing in the 30 highest-ranked stocks among all 3,500, you’d have earned an annualized 31%, or two and half times what Standard & Poor’s 500-stock index returned. Had you confined your investments to the 1,000 largest companies, you’d have earned 23% annulaized, twice the index’s gain.
…But Greenblatt, who as a professional investor knows a few things about investor psychology, foresaw a problem for buyer of his book who attempt to follow the Magic Formula plan: It doesn’t work all the time. On average, it works seven months out of every 12, and three out of every four calendar years.
In other words, it’s not going to beat the market every year. So, a formula that was designed to take the emotion out of investing, is being tweaked out of emotion. Believe it or not, according to Greenblatt, this is actually good news for followers of the formula:
…If every investor jumpted on the Magic Formula bandwagon, says Greenblatt, it would probably stop working because bargains would quickly disappear. But, he says, most people lose patience. They abandon the Magic Formula and go on to some other strategy or fad, leaving the bargains in place for those who persevere.
I’m with Greenblatt on this one. Value investing works, but it doesn’t work every year.
I have written quite a bit about the Magic Formula. If you are interested, you might want to check out these posts:
A Not-So-Good Year For the Magic Formula – A review of 2007’s performance.
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