Magic Formula Investing

MagicDiligence Acquires Magic-Formula-Investing

2008-08-21T19:07:00.000-07:00

A quick note to inform readers of this blog that ownership has now changed hands from Nick to MagicDiligence.com, a site dedicated to finding the best Magic Formula stocks. I don't want to speak too much for Nick, but he actually contacted me about the deal. The blog had been virtually dormant this year as professional limitations were preventing him from updating it. More details to come...

Steve Alexander
Editor, MagicDiligence.com

Does the Magic Formula Work?

2008-03-15T15:14:00.001-07:00

Alex at Contrarian Value Investing has posted his thought on the Magic Formula:

Ever since its release, much has been written whether or not Joel Greenblatt’s “Magic Formula” works. Joel Greenblatt has consistently said that results should be measured over time and every once in a while there would be stretches where the magic formula does not work.

So far the results have been bad. Just about every blog/site testing the magic formula has underperformed the market" Continue Reading

I happen to agree with his overall assessment that we need a longer time frame in which to judge the validity of Greenblatt's formula. That said I am not under performing the market (unless you use a beta adjusted returns).

Anyway check out his site and enjoy your weekend! For more investing related article click here.

See's Candy: A Magic Formula Stock from 1972?

2008-03-04T20:15:00.000-08:00

Shai explores what might have been a Magic Formula stock in 1972:

Let’s look at the prototype of a dream business, our own See’s Candy. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn’t grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. Indeed, I believe that See’s, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry’s earnings.

At See’s, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. (Charlie and I controlled Blue Chip at the time and later merged it into Berkshire.) Last year See’s sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire.

Continue Reading

Hat Tip: Investing Matters

Comments on the Magic Formula Performance to Date

2008-02-12T12:39:00.000-08:00

For some reason I cannot seem to get any text to show up in my post below so I will leave my (limited) thoughts here.

I appologize for not having any real commentary on the markets or on the performance of the Magic Formula. Given the market events of the past year I am proud to report that I have not lost any of my initial investment. In fact, I have performed inline with both benchmarks. Some months found my portfolio crushing the index and other months the index was beating my portfolio to a pulp. Mr. Market is tempormental fellow and many of us had forgotten that fact. I have rather enjoyed some of the gyrations -rather I've enjoyed some market pundits reactions to the gyrations.

In 2007 the general market returned a lumpy 5.5% to investors and my MFI portfolio returned around 4.5%. Accordind to Icarra, this brings my annualized return since inception to 4.9% relative to the S&P 500 annualized return of 3.45%. At the very least "The Little Book that Beats the Market" is beating the market for me. Are you impressed? I'm not. MFI has been a drag on my portfolio for two years. My personal investment selections have been superior every way; however, 2 years is hardly a long time horizon and Mr. Greenblatt deserves more time (I will report back for at least another 2 years). Quite a bit of my success in 2007 (outside of MFI) can be attributed to this site.

Please keep in mind two things: First, when I calculate the MFI performance versus the benchmark I pretend to invest that same dollar amount in the index the same day as the MFI purchase. This means that the timing of the purchas(s) will give different results for the 2006 or 2007 index returns you'll find elsewhere. Second, I have eliminated "averaging down" from the results that I am disclosing. In many cases I have averaged down this strategy significantly changes the result of the magic formula. Since this is hard to duplicate I won't report back on that strategy. Last year my performance included this strategy, but this year my results (including annualized results) DO NOT include any modifications (except some early sells and late buys based more on apathy than anything else). To clarify, the annualized performance stated above doesn't consider the averaging down of 2006 or 2007. I've also eliminated LEAPs from my reported portfolio and I reported equity positions instead.

As I stated last year, in 2007 I hoped to purchase 20 Magic Formula companies. Since one of my previous companies was bought out, I purchased 21 stocks in 2007. Here is a comprohensive list:

True Religion (TRLG)
Pre Paid Legal (PPD)
Omni Vision(OVTI)
Vaalco Energy (EGY)
Motorola (MOT)
3M (MMM)
Teck Cominco (TCK)
Gevity HR (GVHR)
Freeport Copper & Gold (FCX)
Optimal Group(OPMR)
Korn Ferry (KFY)
Harvest Natural Resources (HNR)
Freightcar America (RAIL)
Pinnacle Airlines (PNCL)
Intevac (IVAC)
Heelys (HLYS)
Frontier Oil (FTO)
LCA-Vision (LCAV)
Prudhoe Bay Royalty Trust (BPT)
Barrett Business (BBSI)
IKON Office (IKN)

As you've noticed I post very infrequenly. I've found that writing about a someone else's formula is rather boring especially when that formula's results have been less than impresssive. As such I started watching my investment daily this is an unhealthy habit and to the detrimeant of this blog I successfully broke my habit last year. If you are interested in more regular updates regarding the Magic Formula I suggest you get your fix at MG's site: MFI Diary.

I am considering maintaining a regular blog that would allow me to explore a wider range of investing related topics; however, I've not written anything interesting yet. My family and studying for the Chartered Financial Analyst exams keeps me busy, but I hope to post there from time to time and would love it if you would join me by subscribing to my new feed. My first post introduces the merits of investing in an index. As many MFI followers and professional fund managers can attest to, the S&P 500 index is a formidable foe. Following posts will relate to topics that in my humble opinion will lead to market beating performance. Ignore the dust (formating) and see my thoughts at _________ matters.

Finally Posted: 2007 Magic Formula Investing Results

2008-02-12T12:03:00.001-08:00

2007 Magic Formula Results

2008-01-29T18:29:00.000-08:00

Tune in this Monday to see my 2007 results using the Magic Formula.

Update: Result Posted, Commentary

Greenblatt says this still makes sense.

2007-09-10T20:05:00.000-07:00

I'm not sure if anyone still reads this; however, I came across an update from Joel Greenblatt himself that I thought might be of interest. I'd like to thank Value Investing News for pointing me to Andrew Tobias's site where this quote was found.

This is Joel Greenblatt's response to why the Magic Formula results have been poor so far:

"Each investor who picks 5 or 6 stocks every quarter will have varying results over the short term (meaning a couple of years). However, I gave a class on the results from the large cap model that I reported in the book. During that very successful 18-year period (basically doubling the market’s return), there was a point-to-point 4-year period and a totally non-overlapping 3-year period when the model did not outperform the market averages. That means there were long periods that the model did not beat the market. Yet, looking backward, it is very clear that the strategy (double the market’s return) was a good one. So...what can be learned by one person’s picking a few stocks over a year and a half? Nothing. It either makes sense to buy above average companies at below average prices or it doesn’t. If it does, that still means you need a 3 to 5 year horizon to bear that out."

Yes, I am still following the Magic Formula with awesome results through July of this year and awful results since.

Geoff Gannon: Is There Really A Magic Formula For Investing?

2007-02-25T17:50:00.000-08:00

Recently I have been reacquainted with Geoff Gannon of Gannon On Investing, as he has written some very helpful responses to posts at Value Investing News and posted some articles of significant interest. His blog shouldn't be new to you; I have linked to it in my "blog links" since I started blogging. With any luck he'll start posting more frequently again.

Anyway, I came across this excellent article, by Geoff that contrasts three formulaic investing techniques including Greenblatt's Magic Formula. I hope you enjoy it! Here is an excerpt and a link:

Is There Really A Magic Formula For Investing?
Geoff Gannon

This article looks at investing formulas proposed by three men: Benjamin Graham, David Dreman, and Joel Greenblatt. It then asks whether any of these formulas will lead to above market returns.

One question almost every investor asks at some point is whether it is possible to achieve above market returns by selecting a diversified group of stocks according to some formula, rather than having to evaluate each stock from every angle.

ASPV and RAIL names as top-value small cap picks

2007-02-07T07:17:00.000-08:00

Stockpickr: The Top Small-Cap Value Plays

Excerpt:

As Warren Buffett has said, the three most important words in investing are "margin of safety." Although small-cap companies offer the highest potential reward -- small-caps that graduate to large-caps offer multiple 1,000% returns -- they also are most likely to fall apart and become worthless.

Justadrone: Major Insight?

2007-01-25T07:43:00.000-08:00

The only other Magic Formula blog that read on a regular basis is MG's justadrone.blogspot.com and I'd like to point to that blog once again. The blog is well written and better proof written than my work and the author has a great sense of humor. However, that is not why I am linking there.

MG has put together about a years worth of MFI data consisting of 276 companies that have appeared on the MFI screen. To my recollection this is the first real analysis of the MFI stock as a whole since Greenblatt published "The Little Book that Beats the Market." MG has shared the database with me and I hope to explore it see if there are any early indicators on ways to improve (or at least not screw-up) the fantastic returns that the back test provided.

Any way here is a link and a quote:

The 276 stocks in aggregate, if you simply bought and held them per the MFI rules, would be up 11.9%. If you implemented the rule to sell when they dropped by 20%, you would only be up 7.3% (and with about the same amount of overall volatility).

I'd also like to take this opportunity to link to Value Investing News so that you can share any great value invsting article that you come across with the rest of the community.

Motley Fool: Diligence, Diversity and Dilution

2007-01-21T14:49:00.000-08:00

I came across this excellent post on due diligence, Piotroski, and the Magic Formula. Here is a link and an excerpt:

When you do your DD and start cherry picking from the list, I think you're more likely to eliminate the stocks that will end up being really huge winners than you are to pick them. That's because these are the stocks that are going to be the most difficult to figure out.

As always, I'm interested in your thoughts,

Nick

InvestoBlog: Jamie's [MFI] Experiment in LEAPs

2007-01-19T14:12:00.000-08:00

Most readers of my blog have probably read Greenblatt's The Little Book That Beats The Market, but I'm not sure how many of you have read his earlier book How To Be A Stock Market Genius. In many ways I like his first book better, for example its focus on special situations is of a particular interest to me. One such situation is the use of LEAPs (Options with longer expirations) to simulate Stub stocks. Jamie has conducted a bit of research using the MFI screen and LEAPs; though not statistically significant, I found her research interesting. Here is a link and an excerpt:

I wondered a while back whether buying LEAPs would be a way to leverage the MFI for greater gains. On August 8, I recorded the 38 MFI stocks that had options available. For each stock, I recorded the close price, as well as the close price of Jan. '07, '08 and '09 LEAPs with a strike price just below the close price of the security.

I'm interested in your thoughts and experiences on LEAPs in general and on their application to the Magic Formula. I have used them with great success on Investopedia's simulator game, but I have never used them in real life. Beware of the bid/ask spreads as it can get very pricey!

The Magic Formula Works!

2007-01-16T12:18:00.000-08:00

If you are a long time reader of my humble blog then you remember when I used to post updates on two Magic Formula Portfolios. Unfortunately, my friend purchased a house and was unable to make MFI purchases beyond his initial 7 picks. In fact he even liquidated a couple of his positions to put a down payment on the home. Anyway, he is batting 1.000 as he has made money on all of his purchases. As of today his MFI portfolio is up 30%. That is right he achieved the 30% that Joel Greenblatt all but promised to his faithful followers. Who knows what subsequent purchases would have been, but that is immaterial. Here are his results dividends are not included:

One year Anniversary!!

2007-01-11T13:36:00.000-08:00

Scroll down for the buy/sell update

In my last post I promised to discuss what I have learned over the past year. I think I made some significant mistakes -mistakes that I'd like to help you avoid. Let's get started shall we?

My mistakes can be classified in two ways:

1. Deviating from the Magic Formula
2. See mistake #1

Hmmn. The best advice I can give you is to not deviate from the formula. Why? It would be very arrogant of me to say that I can improve on Mr. Greenblatt's success; however, that is not why you're reading this. Is it? My real mistakes in order of importance:

1. My purchases were not evenly distributed throughout the year and I made too few purchases. Please observe the chart to see my purchase and sell distribution. This mistake was made for several reasons none of which I think are relevant to the Magic Formula so I won't discuss them at this time. Why the liquidation in October? See mistake number 2.

2. Stop Limit Orders. A Failure and a Success?

Follow the preceding link for an example of what I did. One saved me some money and I lost out on future returns on the rest of them. Net opportunity cost? 1.5% of my portfolio -no I'm not going to annualize that for you. Worse yet. That technique never did sit well with my philosophy. To think that I initially considered the Magic Formula a trading philosophy due to the short 1 year holding period. I liquidated positions I held for less than 6 months in some cases. I should be forced to turn in my copy of the Intelligent Investor as well as The Little Book That Beats The Market. I pruned the the flowers to let the weeds grow. My fear of losing what I had gained out-weighed my fear of my laggards under performing. This is a common mistake, I suggest that you don't make it. Sell your winners on the 366th day and your losers on 364.

3. Doubling Down. I still think that this might be a valuable technique and unlike #2 is one that I have used in the past. This increases the volatility of your portfolio. I do not know the real cost or benefit of this technique to my returns, because I "doubled" instead of purchasing a different MFI company. I made very good gains on two of my doubles; both TGIS and MTEX were big winners. I made a bit in RAIL and lost a ton on FDG. I don't consider ALDA a double down situation because I didn't buy it after large drops, but if you think it is in the same category you should know that I got crushed! If I had passed on doubling up and bought PNCL then we would definitely say that this technique has got to go, but there are other dogs that I might have purchase that would make this technique look great. I think the key here is to wait for a 30-50% drop in price that you feel is market, not fundamentally, driven and then buy in. Only time will tell.

Unfortunately, I am running short on time so that is as far in depth as I am able to go. I have made some new purchases and sold two positions on schedule. I sold CATT and CHKE and I must say that I regret selling CHKE because it a well run enterprise with solid future, but I had to sell to stay on schedule. Frankly, I wish I sold CATT when it fell off the list. Anyway here are my new purchases:

1/9 TRLG
1/10 PPD
1/11 OVTI
I have two unfilled orders EGY and VPHM

I plan to hold 20 Magic Formula companies and will make purchases in Jan, Apr, July, Oct.

Your comments are always welcome!

4th Quarter Performance Update

2006-12-29T10:39:00.000-08:00

Well, it has been an interesting Magic (Formula) carpet ride this year. I did and absolutely horrible job following instructions and my results are poorer for it, but I will save my analysis of my mistakes and lessons learned for my next post. This update is about my results 01/11/2006 -12/29/2006. Basically I would have been better off putting my money in the SP500 as I trailed that index ever so slightly. Please keep in mind the return represented by the two benchmarks represents purchases made at the closing price on the same day as my MFI purchases. Please save your comments on my failure to follow the "The Little Book That Beats the Market" for my next post. Hopefully, you achieved a 30% IRR this past year. Please comment on the IRR of your MFI portfolio if you maintain one. Thank you. Merry Christmas and Happy Holidays.

Looking Lean

2006-11-03T13:41:00.000-08:00

Wow, my portfolio is looking lean thanks to the trailing stops that I had place on my top performing positions. No I'm still not convinced that this is a good strategy and it may well be a very poor strategy. I don't think that I went into my MFI purchases with enough due diligence to make a proper selling decision. Yes, I realize that actually analyzing the companies is not part of Mr. Greenblatt's recommendation.

Sold Mannatech today while it was still in the Top 100 $50 Million Market Cap

2006-10-16T14:03:00.000-07:00

My trailing Stop Limit was exercised today at $17.92 but MTEX dropped further to close at $16.65 almost a 13% drop from its previous close. This dropped occurred on no new information as far as I could tell and underlines the volatility that has been common among MFI picks.

If you've been following this blog for a while you'll know that this was the 1st of my Magic Formula purchases and that I doubled my position in June. You'll also remember that MTEX dropped a ton in May after just reaching $20 a share. This time I protected my gains with a trailing stop. It is too early to claim victory. Only time will tell.

I earned a 44%/62% Annualized 56%/281% Annualized respectively on my two MTEX positions. I am quite satisfied with both those returns and will reinvest in Mannatech Inc. if it falls further.

Unfortunately Blogger won't allow me to post any of the images that I want to upload.

Stop Limit executed on 10/6/2006 and 10/12/2006

2006-10-13T15:20:00.000-07:00

Earlier today I saw that a few of the stop limit orders I placed last month were executed. I sold my positions in American Eagle Outfitters (AEOS) and Thomas Group (TGIS).

AEOS is now $3 above the price I sold it for so that is disappointing, but quite frankly with a P/E above 22 I'm not very comfortable owning a retail company with no long-term competitive advantage. Hell, I don't exactly have my finger on the pulse of American teens. You could argue that I never knew what was cool when I was a teen either!

The TGIS sell was unfortunate as well. I could have sold for $16 a while back and didn't. I think I place my stop too high based on the day to day price changes in this stock. Oh well what's done is done.

Time to go hunting for my next MFI purchase.

Anyway, since these are my first closed MFI positions I thought I'd share my spreadsheet's new format. Let me know if it's clear enough.

3rd Quarter Performance

2006-09-29T14:18:00.000-07:00

First I must appologize for either blogger or myself. I had posted my results on Friday September 29th only to find that they never posted. The image file was saved but, the blog never updated. Anyway, I'm sorry if you were looking forward to the update.

Please see the chart for my 3rd quarter results. Yes, this includes dividends and reflect my results as of 9/29/2006 . Please note that I am beating the Russell 2000 but I am losing to the S&P500 index.

Also of note. After watching this video of Joel Greenblatt at Columbia University I've decided to further deviate from the Magic Formula.

http://merlin.gsb.columbia.edu:8080/ramgen/video3/admin/alumni/Reunion_2006/Reunion_4-8-06_Greenwald.rm

It has been 10 months since I've read "The Little Book That Beats The Market" so it was nice to have a little refresher course on the theories and rules. In order for the Magic Formula to be a complete system, and to be able to back test the formula, Joel G. had to give instructions on when to sell our MFI positions. One year is a completely arbitrary number he could of easily chosen 6 months or even a 3 year holding period.

As value investors know, even if a company is currently undervalued by any and even all measurements, there is no guarantee that the market will agree with you anytime soon, if ever. If the market does respond quickly and reaches a fair value or we earn a return that we as investors find satisfactory, why not sell our position(s) earlier than 1 year? If the market takes longer than a year to fully recognize the value of the companies we purchase, why not hold the position longer (as long as we still find the prospects of the company favorable)?

Today, I place several Stop Limit orders in on my MFI portfolio. This year has been a very up and down market and is currently trading at a multi year high. Many MFI companies are in industries that are outside my circle of competence and I found it prudent to protect some of my gains. I'll let you know how this works out.

Wrong side of a hedge fund's liquidation...RAIL?

2006-09-28T12:59:00.001-07:00

Months ago I asserted that it was possible that I was losing money in RAIL because insiders were selling their positions. Recently, Pirate Captial LLC. has admitted to liquidating their position in RAIL without disclosing their liquidation in a timely manner. See the related article here.

I've not taken the time to read Pirate's amended filings, but I wouldn't be surprised if I was on the opposite end of Pirate's first attempts to slowly move out of their substantial position in Freightcar America Inc.

Pirate Capital, known for it activist style investing, has recently closed the door to new investors and had several analyst leave. This might also affect MFI company PWEI which if I remember correctly was a potential target if the Pirate.

I'll update on my quarterly performance tomorrow.

-Nick

A Bit of hope...when your MFI pick drops 50%or more.

2006-09-22T23:05:00.000-07:00

I am sitting at my monitor at 11pm on a Friday night searching for investment ideas beyond the Magic Formula, when I stumble across a Motley Fool article by Tom Garner. Tom is one of the founders of the Fool. Anyway, the kid has been asleep in bed for hours but given a title like "Let's Find the Next 60-Bagger" ,I must be the one dreaming- right? Maybe.

Tom's lesson for us isn't about dreaming its about fundamentals and sticking to your guns in the face of 50% drops in Market Capitalization in a short period of time. Take a look at the article, I know a few of you have experienced a significant decline in the price of your pick once if not thrice since following Greenblatt. Personally you know of my experience with ALDA, but I know of at least a dozen MFI stocks that have done this while on and off the list...hold fast and check out the Fool. It might just be part of the 60-Bagger club (60 Bagger returns 60,000%.)

I find it interesting that depending on the time of purchase that one person's worst performing position is another's top performer-even within the same quarter. It really shows you that timing is everything, but don't let that fool you into thinking you can time the market...if you could you wouldn't be reading this or Joel Greenblatt for that matter!

Good Luck and tune in next Friday for my Third Quarter update, hopefully I'll be crushing my benchmark!

-Nick

Q: What is 10% annualized?

2006-09-14T15:04:00.000-07:00

A: Roughly the difference between sticking to the Magic Formula vs. Me Deviating from the formula. Observe my result if I had not deviated:

Though my returns for my deviated porfolio stand at nearly 7% annualized-had I not deviated, had I made NO purchases the result of my porfolio would be that of the above spreadsheet. A 16% Internal Rate of Return, not bad! This unfortunately is not an accurate alternate ending if you will. I made 6 additional purchases of MFI stocks while they were still on the list. That capital would have gone to other MFI stock in my portfolio, increasing my diversification and potentially affecting my rate of return. For better or worse, we'll never know. What I do know is that I would have more money if I never messed with the formula and that is my lesson for you.

Do not underestimate the difficulty of sticking to the formula. It seems only human to want to try to improve upon the model. That said, I'm still making money but not significantly more than the current CD rates.

My question for you dear reader: Would you prefer to have this blog focus on my struggles (read: deviations- factual accounts of my experiences) or should I tailor this to a strict adherence to the model (Read: leave out reporting of any deviations) ?

I only ask because the comment below would leave me to believe that a strict adherence would be more beneficial. Intuitively, sticking to my actual experience while anecdotal might be more realistic and therefore more helpful. Please post a comment to let me know your preference!!

Anonymous said...

Nick,
I've been MFIing almost exactly as long as you. On a $150K investment I've made $12.5K so far. One thing I've noticed from your blog is that you are NOT following the directions!
I know that is harsh but I'm trying to help you. You're supposed to buy 5-7 stocks, wait 3 months or so and buy another 5-7 stocks, etc. etc. until you have 25-30 DIFFERENT stocks. I try to buy my "blocks" all on the same day. I never rebuy a stock...ever! I'm going to buy another 7 stocks for 50K in November all on the same day. Also, somewhere in the book or on the website is the phrase "no further analysis of the selected picks is necessary" HEELLLLOOOOO! You're working too hard at this....it was meant to be a brain dead process. You might as well take the list of the top whatever and throw darts at it to pick 'em. I love investing this way because it's about one step above playing in a sandbox. Try to keep it that way :)

1:50 PM

I agree completely with the comment. Unfortunately, I hate brain-dead activities, but I will try to stick to the model in the future- of course that was my objective when I started doing this in January!

For those doing actual analysis some tips from the CFA Institute:

Till next time-

Bill Rempel on the Magic Formula

2006-09-12T15:12:00.000-07:00

http://www.billakanodoodahs.com/?p=10

Great Day for MFI

2006-09-12T15:11:00.000-07:00

NSS a MFI pick that I didn't invest in was up 40% yesterday on the news of a buyout. Today my portfolio jumped over 3%.

Infrequent updates and YTD results!

2006-08-29T14:15:00.000-07:00

Well, I've received several e-mails over the last week asking if I quit after ALDA tanked or simply asking for me to update this. Frankly, I have been doing some soul searching career-wise. I'm bored with my role at the bank and am exploring options outside of my current expertise; this move will come with a paycut and a commitment. I'm far from making a decision but starting very soon I will start studying for the 2007 CFA exam using the older material until the new ones are released. Anyway, I'm sure no-one really care about what is on my mind outside of the Magic Formula even then you probably on care to keep yourself entertained. I though you deserved some explanation...

Looking at my results you may feel discouraged; however, I would caution you from making any conclusions as to the success of the model. First, this is a long term methodology and as such we need to wait 3-5yrs before we determine whether we have been successful or not. Please realize that my last 6 MFI purchases, though on the MF list, were a deviation from MFI as Greenblatt intended. Please also realize though my deviation was very profitable immediately (TGIS up 86%) it became a large net loss (as TGIS went back down and ALDA dropped 40%). Despite my futzing with the formula I am not losing money...until you account for inflation. Give it time!

On a much more positive note take a look at my friends MFI picks:

Pretty impressive unfortunately (or fortunately) he has made no further MFI purchases, but he is happy with the results. FYI IVII popped 30% yesterday!

Till you harass me for update,
Nick