Magic Formula Performance to Date
One of the readers here at Fat Pitch Financials revisited one of my original posts on Joel Greenblatt’s Magic Formula. The Magic Formula is detailed in Greenblatt’s latest book, The Little Book That Beats the Market
RG crunched some performance numbers on the stocks I obtained from Magic Formula Investing website, which I listed in my January 24, 2006 post. He then posted his work in the following comment on my post, “Exploring Greenblatt’s Magic Formula“:
I just ran a quick test of the stocks listed in the Jan 24 column. The Magic Formula is down 5.55% from 01/24/06 to 07/24/06. The Russell 2000 is down 6.41% and the S&P500 is down 0.47% during the same time period.
Ticker 1/24/2006 7/24/2006
AEOS 25.39 33.34 31.31%
ANIK 10.5 9.86 -6.10%
HRB 24.9 23 -7.63%
CALL 4.79 3.53 -26.30%
CATT 14.55 9.98 -31.41%
CLCT 15.07 12.38 -17.85%
DLX 28.4 13.57 -52.22%
FORD 10.55 6.05 -42.65%
FTD 10.02 14.86 48.30%
GBEL 11.95 8.6 -28.03%
INSP 23.7 22.02 -7.09%
ISSC 14.01 16 14.20%
IVII 10.99 8.86 -19.38%
JAKK 22.57 17.04 -24.50%
KSWS 31.32 23.55 -24.81%
KG 17.99 17.09 -5.00%
KFY 19.34 18.38 -4.96%
KOSP 45.17 39.27 -13.06%
MGLN 33.85 44.15 30.43%
MTEX 13.84 13.39 -3.25%
MVL 16.5 18.03 9.27%
NOOF 6.49 6.76 4.16%
UNTD 14.48 10.77 -25.62%
EGY 5.77 8.61 49.22%
VTRU 38.22 43.65 14.21%Average 18.8144 17.7096 -5.55%
S&P 500 1267 1261
-0.47%Rus 2000 718 672
-6.41%
There is no clear conclusion that can be made from this short performance period, but I thought you would find these numbers to be interesting. I must admit that I have not yet used the Magic Formula to make any investment decisions.
I have started to become a bit more sceptical of using this formula to automatically build an investment portfolio. However, I still see it as a decent screening tool to identify potential opportunities.
I’ve used http://www.marketocracy.com to test the magic formula since November 12, 2005.
Every two months I have “purchased” five stocks investing approximately $33300 on each.
To date the porfolio has lost 7.35% vs S&P 500 +3.43. Stock symbols include:
Purchased
November: AVP, YCC, KSWS, TBL, BSX
January: TPX, LIZ, MT, APPB, TUES
March: HOV, DVN, APOL, MNI, GCI
May: DELL, NZT, CDWC, FII, MSFT
July: ABBI, ISCA, FMX, PETM, CCL
It is definitely more art than science. I am beginning to think that the most important part is the size of the moat. That is also the most difficult part to examine effectively. Phil Town’s “Big 5” tools are great, but again, he would tell you that understanding the business and understanding the moat are essential — you cannot just crunch numbers.
Thanks for doing the research on this. It’s entertaining and I’m glad you’re not investing real cash.
You can take a look at my MFI result vs. the SP500 and Russell2000 here:
http://magic-formula-investing.blogspot.com/2006/07/magic-formula-investing-2nd-quarter.html
You should look at the forums in the vinvesting website for a slightly longer timeframe. Someone had picked five stocks using Greenblatt’s screen in November, 2005. I checked how those stocks were doing and they were up about 19.5% in 8 months (vs. 1.4% for the S&P).
Nick, thanks for sharing your results, and thanks Glen for pointing out the November 2005 picks.
I’ve used http://www.marketocracy.com to test the magic formula since November 12, 2005.
Every two months I have “purchased” five stocks investing approximately $33300 on each.
As of September 25th the porfolio has gained .76% vs S&P 500 +9.20% Stock symbols include:
Purchased
November: AVP, YCC, KSWS, TBL, BSX
January: TPX, LIZ, MT, APPB, TUES
March: HOV, DVN, APOL, MNI, GCI
May: DELL, NZT, CDWC, FII, MSFT
July: ABBI, ISCA, FMX, PETM, CCL
September: RS, CRS, CHS, ATU, BRY
Craig –
Thanks for sharing your Magic Formula results. I take it that you were not fully invested during that time. Can you figure out the returns for the invested dollars only?
My sample spreadsheet that calculates IRR might provide a better picture on how your purchases actually performed without the drag of the cash portion of your portfolio. Contact me if you need some help in doing this.
Since the 2nd Quarter results seemed so popular, here are my results as of the end of the 3rd QTR.
http://magic-formula-investing.blogspot.com/2006/09/3rd-quarter-performance.html
Enjoy,
Nick
Hi Nick –
Thanks for sharing your recent results.
Just wanted to let you all know there is now a mutual fund that follows the “Little Book That Beats The Market” Method of Investing the Catalyst Value Fund http://www.catalystmutualfunds.com
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
I, too, am trying the magic formula.
My first set of stocks were purchased in late July and August:
– DLX (up 50%)
– ALDA (up 6.4%)
– EuroZinc Mining which merged into LMC (up 43.5%)
– These stocks benefited from the market rally and did well.
My second set of stocks were purchased Sept-Oct
– DPZ (up 6.5%)
– FDG (down 22%)
– FCX (up 7.5%)
– RAIL (up 8%)
– JRC (up 17%)
– KCI (up 33%)
– LCAV (up 3%)
– DGX (up 7%)
I am pretty pleased to have so many stocks making positive gains. The exception is FDG which is painful but has an outstanding dividend so tempers the loss. Personally, I have never been able to pick this many gaining stocks in the past.
I am now starting my 3rd wave of stocks and am learning a lot in the process. I am not limiting myself to the stock screen for the top 25 stocks with market cap $50m or greater. I am looking at the top 100 at different market caps looking for opportunities. A couple regrets are I didn’t purchase Abercrombie and Fitch and Aeropostale when these showed up on the screen. I have missed many others such as ELOS and ViroPharma and ASEI which have seen great gains. All in all, I’m pretty happy so far.
Here is my most recent performance update: http://magic-formula-investing.blogspot.com/2006/12/4th-quarter-performance-update.html
Merry Christmas and Happy Holidays!
-Nick
Thanks for sharing your results Jim.
Nick, also thank’s for sharing that link to the detailed post on your Magic Formula portfolio performance. Do you think you would have done better if you stuck to the system a bit more closely?
George,
I use the list as a “screen” and then like to read about the company and check fundamentals before purchasing. I also like to look beyond the top 25 @ 5om market cap to see what else may be on sale. Several of the companies in the top 25 have big issues to overcome and therefore may not recover within the one year timeframe. Examples are (PortalPlayer lost 80% of business with Apple; OVTI was declaring that competition was increasing and they were lowering their growth rates going forward). But, given this issues do arise such as I purchased FDG which was in the top 25 and later Canada passed a law which significantly effected Royal Trusts tax status such as FDG (this new law will come into play in 2011) which evidently has impacted the stock price. At the end of the day, as Cramer says, if you can pick winners greater than 50% of the time then you are on your way to riches and I think the “screen” helps. Consider such examples as Abercrombie and Fitch, American Eagle Outfitters, ELOS, Viropharma which all saw great % gains and were included in the screens at one point.
Hope this helps and please share your thoughts, too
I’ve used http://www.marketocracy.com to test the magic formula since November 12, 2005. Every two months I have “purchased” five stocks investing approximately $33300 on each. At the end of one year the shares are sold and replaced with a new set. To date the porfolio has earned 13.3 % vs S&P 500 18.5%. Stock symbols include:
Purchased
November: AVP, YCC, KSWS, TBL, BSX (SOLD – AVG GAIN = 9.9%)
January: TPX, LIZ, MT, APPB, TUES (SOLD – AVG GAIN = 25.4%)
March: HOV, DVN, APOL, MNI, GCI
May: DELL, NZT, CDWC, FII, MSFT
July: ABBI, ISCA, FMX, PETM, CCL
Sept: RS, CRS, CHS, ATU, BRY
Nov: XEC, MSM, MDT, WMT, BUD
Jan 2007: FWRD, CR, EOG, NSM, MYL
Craig,
What inputs (#, Market Cap) are you using at magicformulainvesting.com? It looks like you are using 2 Billion.
Number 1. In order to really test this theory it might be required to run these for a long time span not just 1 year. Number 2. Perhaps the attempt to use it as a screener is the very reason for failure because the formula was designed to use randomly. Its the whole point of it. 3. You have to buy and keep rolling over 30 stocks a year- in every sector evenly.
I have not tested it but I can say that if you only run it for short periods like 1 year it is not supposed to really prove anything.
Wilson Flipson
Wilson:
I wouldn’t argue with you that you need a longer period of time but this is an on-going study, I’m not backtesting. I wouldn’t consider the theory a success or failure at this point. Secondly, I think your wrong that the formula is designed to be used randomly. I believe in the book that Joel Greenblatt mentions that he
“finetunes” his selection, in fact he mentions that he ranks by ROI and PE and selects the stocks with the highest combined ranking.
I’ve used http://www.marketocracy.com to test the magic formula since November 12, 2005. Every two months I have “purchased” five stocks investing approximately $33300 on each. At the end of one year the shares are sold and replaced with a new set. To date the porfolio has earned 9.89 % vs S&P 500 15.28%. Stock symbols include:
Purchased
November: AVP, YCC, KSWS, TBL, BSX (SOLD – AVG GAIN = 9.9%)
January: TPX, LIZ, MT, APPB, TUES (SOLD – AVG GAIN = 25.4%)
March: HOV, DVN, APOL, MNI, GCI (SOLD – AVG LOSS = 17.9%)
May: DELL, NZT, CDWC, FII, MSFT
July: ABBI, ISCA, FMX, PETM, CCL
Sept: RS, CRS, CHS, ATU, BRY
Nov: XEC, MSM, MDT, WMT, BUD
Jan 2007: FWRD, CR, EOG, NSM, MYL
March 2007: BRL, UPS, BBY, UTX, GPS)
There is something that I do not understand or have a misconception about regarding the Magic Formula and would be grateful if I could get an answer.
I will use a company, Jackson Hewitt (JTX) to illustrate my question.
The Magic Formula website included JTX on April 23, 07 and contains the following information about the company:
Jackson Hewitt Tax Service Inc JTX 958.70 9% > 100% 04/22 01/31
The fact that JTX is on the “Magic” site means that it fits Greenblatt’s criteria.
Greenberg’s “Little Book That Beats the Market” indicates (page 136) that one could use PE and ROA as surrogates for Earning Yield and Return of Capital.
When I researched the stock on Yahoo on April 23, 07, it indicated that JTX has a PE of 18.91 and an ROA (ttm) 10.50%
If JTX has such a low ROA and a relatively high PE, why is this stock (and many others like it) on the Magic Formula screen?
What is it that I do not understand?
I’ve used http://www.marketocracy.com to test the magic formula since November 12, 2005. Every two months I have “purchased” five stocks investing approximately $33300 on each. At the end of one year the shares are sold and replaced with a new set. To date the porfolio has earned 19.02 % vs S&P 500 25.08%. Stock symbols include:
Purchased
November: AVP, YCC, KSWS, TBL, BSX (SOLD – AVG GAIN = 9.9%)
January: TPX, LIZ, MT, APPB, TUES (SOLD – AVG GAIN = 25.4%)
March: HOV, DVN, APOL, MNI, GCI (SOLD – AVG LOSS = 17.9%)
May: DELL, NZT, CDWC, FII, MSFT (SOLD – AVG GAIN = 23.4%)
July: ABBI, ISCA, FMX, PETM, CCL
Sept: RS, CRS, CHS, ATU, BRY
Nov: XEC, MSM, MDT, WMT, BUD
Jan 2007: FWRD, CR, EOG, NSM, MYL
March 2007: BRL, UPS, BBY, UTX, GPS
May 2007: CHK, GGG, JNJ, LIZ, CTAS
Dan,
Are you including dividends received in your calculations of return? The S&P500 does include dividends.
The following MagicFormula picks show returns to-date and do not include dividends.
Jul-Aug ’06 ALDA,LMC,DLX (+36.43%)
*Unfortunately, I sold DLX after a 59% gain – it is now up 154%
Sep-Oct ’06 DPZ,FDG,FCX,RAIL,JRC,KCI,LCAV,DGX (+23.07%)
*Excellent dividends from FDG not included
*Sold JRC a few weeks ago at a 2.5% loss
Nov-Jan ’06 ADDL,CVX,FDG,GW,HAL,HW,NXG,USPH (+9%)
*I increased my position in FDG after big drop from 1st purchase and this has come back very well.
Feb-Mar ’07 ARXT,DVN,PMD,DGX,USNA (+9%)
*DVN did not show up on the list but fundamentals were very much the same as CVX so I purchased.
Jim
Craig:
When you “purchase” 5 stocks every two months, do you just pick them at random from the top 25 list over some threshold capitalization? Or are you implementing an additional filter to winnow the list down to five candidates?
For me, it makes sense to eliminate any companies that have done something to invalidate their magic formula ranking, such as restating their earnings. This requires a bit of investigation of past news reports, though.
Alex
Alex,
I use the Morningstar Premium Stock Screener to select the five stocks each month using the following criteria:
Price / Earnings Ratio – Current = 6.59)
and (Morningstar Rating >= Four Stars)
and (Economic Moat >= Narrow)
and (Stock Industry Group not = Banks)
and (Stock Industry Group not = Insurance)
I then pick the top 5 stocks whoses Price to Fair Value are the lowest, excluding any stocks previously
choosen or that are in the same industry. I don’t look at capitalization.
Craig,
Are you including dividends in your ROI calculation? Sorry, I sent this Q to Dan incorrectly.
Jim,
Yes and No. The 19.02% shown in my May 5th includes dividends, interest on Cash Balances (which is about $100,000) less a 2% annual maintenance fee on fund assets calculated calculated by marketocracy. Where I show the individual months sales the % increase/decrease is between purchase and sale stock values only and does not include dividends, interest or any other charges.
Craig,
Thanks for the explanation. Do you have any success in duplicating the lists generated by http://www.magicformula.com using the Morningstar premium screener? That is, did the stocks you purchased on a particular day also show up in the “top 25 stocks over $1 million capitalization” that the Magic Formula website shows?
Your filtering uses P/E ratio and seems to ignore RoC, so I’m wondering if the stocks you find are really the same as what the Magic Formula finds. Your strategy seems quite sound considering your performance to date, but if your intent is to test the Magic Formula rankings, I’m not sure you’re actually doing that.
I have been trying things with the Microsoft Money screener (using similar criteria with P/E, RoA, and a few others) but at best my list will have maybe 2 or 3 stocks in common with the Magic Formula list.
Alex
Actually I copied my formula incorrectly, it should read:
Price / Earnings Ratio – Current = 6.59) *
Morningstar Rating >= Four Stars)
(Economic Moat >= Narrow)
(Stock Industry Group not = Banks)
(Stock Industry Group not = Insurance)
* the top quartile.
I believe you’ll find that Greenblatt mentions that you would substitute ROA for ROIC. I don’t really refer to the magicformula site. I wanted to develop
a test with a site that I was sure would be around for a while. I think the criteria I use approximates the Magic formula theory. If it doesn’t I don’t really care since I’m testing the theory for myself.
I wouldn’t use it for investing for myself but I just wanted to see if it would approximate the 40% returns Greenblatt said he is making.
With regards to using Microsoft Money, I wouldn’t worry if every stock wasn’t on the magicformula list.
I don’t think it’s an exact science. It’s more important to understand the theory so you can understand how it applies.
My copy isn’t working again.
Return on Assets – Trailing 12 mo. > 6.59
P/E Ratio – Current 4 Stars
Economic Moat > Narrow
I’ve used http://www.marketocracy.com to test the magic formula since November 12, 2005. Every two months I have “purchased” five stocks investing approximately $33300 on each. At the end of one year the shares are sold and replaced with a new set. To date the porfolio has earned 23.2% vs S&P 500 29.1%. For the past twelve months the Magic Formula portfolio has out gained the S&P 500 35.5% to 27.4%. Stock symbols include:
Purchased
November: AVP, YCC, KSWS, TBL, BSX (SOLD – AVG GAIN = 9.9%)
January: TPX, LIZ, MT, APPB, TUES (SOLD – AVG GAIN = 25.4%)
March: HOV, DVN, APOL, MNI, GCI (SOLD – AVG LOSS = 17.9%)
May: DELL, NZT, CDWC, FII, MSFT (SOLD – AVG GAIN = 23.4%)
July: ABBI, ISCA, FMX, PETM, CCL (SOLD – AVG GAIN = 22.7%)
Sept: RS, CRS, CHS, ATU, BRY
Nov: XEC, MSM, MDT, WMT, BUD
Jan 2007: FWRD, CR, EOG, NSM, MYL
March 2007: BRL, UPS, BBY, UTX, GPS
May 2007: CHK, GGG, JNJ, LIZ, CTAS
June 2007: SAI, CCL, LOW, WSM, DGX
Hey, my name is Kenny. I am new to investing and just finished reading the book. Within the next month i am going to buy my fist 5. I noticed in earlier postings some of you guys were talking about picking 5 at random or doing research. Any pointers on how to pick the right 5? According to the book, we do not need to do further research because he already provides the best stocks to us. I could use any pointers you “veterans” might have for a 21 year old to get rich.
Kenny,
If you want to become “rich” I would suggest you not pick stock randomly. Learn as much as you possibly can about valuing a company. Read as much as you can about top flight investors such as Warren Buffet, Eddie Lampert, Boone Pickens, Ian Cummings, Mohnish Pabrai, Martin Witman, Seth Klarman, Bruce Berkowitz, etc. Test your assumptions on sites such as http://www.marketocracy.com for a year or two and then start investing. Best of Luck.
Kenny,
A few thoughts:
1) starting at 21 yrs old is a HUGE advantage in getting rich (GREAT Job!)
2) don’t be afraid (you cannot pick winners 100% of the time so you will lose money on some stocks and frankly you will learn alot about yourself and your approach. And there is some LUCK to this as well – look at Buffet’s record and he caught a couple of great breaks along the way.
3) personally, I don’t believe in picking only from the top 25 – I prefer to read about the business and then decide. Lots of examples of losses in this string of emails (FDG initially lost alot and has gained alot back; ALDA lost and is working back; PortalPlayer was predominantly with Apple and Apple dropped them so they dropped like a rock). Read, read, read.
4) Be careful when buying stocks around quarterly reporting times. I have seen big jumps and big falls around this time.
5) I have seen some stocks selected in the top 25 stay in the top 25 for a couple of quarters then take off – so watch the news and if all looks good, stay patient. Palm and Frontier Oil and FDG were good examples of this and all rebounded nicely.
6) Personally, I like the idea of selling stocks at 1 yr to help me with the discipline to sell winners. I have sold one loser prior to 1 year (JRC newspaper) because I didn’t like the business and ended up saving a couple bucks a share.
Craig,
I will post numbers soon. Just need to get some time to pull together. Thanks for sharing!!
Jim
Kenny,
If you start out at 21, that’s great. If you have an employer that offers you a 401K, max it out. I’m pushing 50 now, and I can tell you that the sooner you start investing intelligently (NOT speculating, but investing) the sooner you can retire.
As to the Magic Formula (MF): What I do is look at the top 25 over $1 million cap on the MF web site. I filter the stocks like this:
1. Eliminate those stocks that have earnings data older than 3 months (which is nearly ALL stocks listed at this time; the MF site hasn’t yet updated its database for the recent release of June earnings). At this time there is nothing I would invest in because the financial data are way out of date. I don’t invest in MF stocks the week before earnings reports are due, either.
2. Make sure that the company you pick hasn’t restated their earnings, or had any other accounting irregularities since their last financial statement (you have to spend time looking up news reports). If a company changed something in their accounting, the ranking in Magic Formula is invalid.
3. If the stock has split (in either direction) since its last financial statement, or issued a large dividend, the magic formula ranking is invalid. Ignore this stock.
Other than that, try to buy an equal dollar amount of each stock until your account is full. NOT an equal number of shares. You don’t have to buy round lots. I often buy stock in multiples of 10 shares.
I set stop-losses and targets too. I don’t wait a year to unload a stock. I won’t risk more than 1-2% of my equity on any position (risk isn’t how much you invest, but how much you lose if stopped out). I raise my stop to new support levels as time goes on, and I sell it (or set a very close stoploss) if it hits my target profit of 25%. If it drops off the MF list and hasn’t made a profit yet, I’ll dump it then too. You may not like the tax penalties for short-term trades, but if you can make up for it with larger returns, it’s worth it. For a young person starting out in a low tax bracket, short-term trading is probably worth doing too.
-Alex
I’ve been trading a REAL MONEY “magic formula” portfolio since the middle of last year. The current holdings are listed in the side bar of my website (using google docs to provide live price data and XIRR calculation). As I’m investing from Australia via a US-broker linked to my local Comsec broking account it’s too expensive to trade small amounts often. So I’ve modified the process to select ONE stock each month to buy approx. US$5000 worth. I’ll hold each stock for 18 months before selling it, and rollover the money into a new stock pick at that time. I’m still in the accumulation phase – I’ll be fully invested in 18 stocks (around US$90K) by the end of this year. So far the returns have been OK in USD, but rather sad in AUD dollar terms due to the rise in the Aussie dollar.
In regards to the actual stock picking processs – I use the magicformulainvesting.com website with a $127m filter to list 100 candidate stocks. I then short-list those that have pre-tax return on capital >100% and pre-tax earning yield over 10% (higher the better). I then exclude those stocks that I feel may have ben included due to unsustainable profit spikes (eg. resources stocks), and have a look at the 12 month price chart for the remaining candidates. I like a stock that has slumped during the early part of the past 12-months, but has now bottomed out and has started to trend upwards for the past couple of months. It’s no good for a stock to be good value if the “market” hasn’t started to re-rate the stock.
I have quick browse through the company summary and recent news to check for any obvious red flags before placing my monthly buy order, but I don’t spend time researching the financials in detail as I don’t think this will add much extra value. Each stock pick only represents 0.5% of my overall net worth, and a portfolio of 18 stocks will have diversified away most non-market risk from my “little book” portfolio anyhow.
Regards
http://enoughwealth.com
Ok, so i bought my first stocks last wednesday {then the market crashed thursday and friday}. i ended up picking RAIL, ICFI, IVAC, MTEX, USHS, and EGY. i put 250 in each for a total of 1500 and i plan on doing another 1500 in about 3 months or so. Do any of you know anything about any of these companys or own them? I read some comments about all of them and they seem pretty solid.
RAIL and ICFI are good companies fundamentally. EGY has been a big loser for me, but is cheaper now. Personally, I have selected stocks every 2 months, which means that I select every 2 months over a 7 month period and then wait 5 months to start again.
I started the formula in December of 2005. I did 40% in 2006 and am up about 13.9% year to date. The account did decrease about 8% from Wednesday to Friday of last week.
Finally Monish Pabrai speaks very highly of the formula in his latest book. The formula works. Stick with it.
Corrected email address is jherbert@gstoyota.com
Looks like its about time for another update from Craig. I am interested to see what you are going to go with for your next purchases since its about time for me to buy again. Is anyone up from july purchases? I know im down. Looking foward to another update.
This is a great website for value investing
To close out the year 2007, I calculated my investment returns on Magic Formula stocks (gain/loss + dividends – commissions). My stocks were:
Aldila +16.28%
Deluxe +60.98% (got scared, sold early,missed double)
Fording +62%
FCX +103%
RAIL -21.6%
JRC -5.9% (sold early, would have lost +100%)
KCI +101%
LCAV -7% (sold early with credit crisis)
USPH +18.28%
GW -25%
ARXT +17% (sold early on generic news, missed $s)
CRYP -13%
Overall was a good year although the last 6 months were volatile.
Will be interesting to see what 2008 brings. I kept purchasing PMTI (Palomar Tech) on the way down and am currently sitting on a loss of 50% with much more than the 5% of total portfolio invested in this stock. Soooo, hopefully this comes back. I have listened to conference calls, read reports, and saw the latest news on the Gillette deal which can very well turn out to be good news (remember, they are working together on a “home” version). They are expanding internationally (Europe, Brazil), too, which should help.
Happy New Year to everyone and good luck!
My updated results are up! 2007
Would someone please explain what pre tax earnings yield & pre tax return on capital mean? I have never used this Magic Formula yet. I have read the book, it’s been awhile, I plan on reading it again soon.
Jamie,
Joel prefers to look at “pre-tax” earnings and return on capital because, as he states, companies are taxed at different rates and have different levels of debt. So, by comparing “pre-tax” then he can compare companies equally. A couple of examples to illustrate:
1) R&D intensive companies receive tax incentives
2) Int’l co’s can lower their effective tax rate by setting up operations in other countries.
Here is a a video of Joel Greenblatt at Columbia and he summarizes the formula and towards the end discusses your question –> http://valueinvestingresource.blogspot.com/2007/06/joel-greenblatt-video-columbia-reunion.html
Hope this helps.
Fellow Magic Formula investors, is anyone worried about the effects of “inflation” on the Magic Formula approach? When I look at the book, the time periods assessed (1990-2005) were periods of consistently low inflation. It appears we are moving toward higher inflation and am wondering what this will mean to Magic Formula investors.
Thanks for your thoughts
It is amazing to look at the list of stocks selected in 2006 vs. the list shown today. Several of the company names are the same demonstrating the stock prices increased then decreased again. A good reason to “sell”.
Is this thread still being used? I started the MF in October and am up 10% as of today. I have bought 8 stocks over the past 4 months for a total of $8,000. I plan on investing $20,000 total. (I wish I could do more but I am in law school). I’d like to know if this thread is still being used because I think it has a lot of relevant information.
I have started an MFI portfolio at http://www.eemagicformula.com in august 2011 you can have a look.