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What a difference a year makes! In 2008, the S&P 500 had its worst year in the history of the index, plummeting nearly 40%. I said in the 2008 year in review that those that had the intestinal fortitude to hold equities through that bloodbath would be handsomely rewarded over the next few years. It turned out that it only took one year to see some nice gains. SPY, the S&P 500 ETF, appreciated over 26% in 2009.

Right now, many equity analysts are fretting about the index being at historically high price-to-earnings multiples, but we must remember that those multiples are against depressed earnings in 2009. As the economy recovers, the earnings part of the multiple should rise, and prices should follow suit. MagicDiligence still believes there is upside in stock prices from current levels.

2009 was a great year for Joel Greenblatt's Magic Formula Investing (detailed in his book, The Little Book that Beats the Market). MagicDiligence uses three Magic Formula screens: the top 50 stocks over 50 million market cap, top 50 over 1 billion, and top 30 over 3 billion. However, for the first few months of the year the "old" top 100 over 50 million and top 50 over 2 billion screens were used. As a result, I've included just the 50 million screen and the 2-3 billion screens as "small" and "large" cap. Below is a table that shows the results of buying the entire Magic Formula screens once each month this year, and their aggregate performance against the S&P 500 (created using the Magic Formula Historical Performance Tool):

DateSmallvs. S&PLargevs. S&P
01/15/09 57.94% 25.91% 66.21% 34.18%
02/13/09 64.46% 29.81% 55.37% 20.71%
03/16/09 92.77% 45.87% 66.42% 19.52%
04/15/09 44.20% 13.48% 45.68% 14.96%
05/15/09 37.28% 11.66% 29.43% 3.81%
06/15/09 28.49% 8.53% 17.42% -2.54%
07/15/09 21.06% 1.57% 24.94% 4.44%
08/14/09 9.66% -0.87% 11.58% 1.01%
09/15/09 4.78% -0.63% 6.51% 1.10%
10/15/09 0.74% -0.84% 1.63% 0.05%
11/16/09 4.96% 4.76% -0.57% -0.78%
12/15/09 3.40% 3.32% 0.35% 0.27%

For the first half of the year, the Magic Formula decimated the S&P 500. In fact, at the market nadir on March 9, the small-cap MFI screen averaged over 100% appreciation per position, which is really amazing. Relative performance tailed off significantly after July, with the large caps making up some ground, before this trend reversed again at the end of the year.

Last year, we observed that the small cap screen generally outperformed the large cap one, as indicated by Greenblatt in his book. This year it was almost 50/50, with small caps and large caps each "winning" 6 months each, although the magnitude of outperformance by small caps in March and May gave them the edge in overall gains. Following MFI in 2009 would have beat the market in 9 out of 12 months for small caps, and 10 out of 12 months for large caps.

MagicDiligence was also impressed at the sheer number of Magic Formula stocks that could have delivered an investor a double or better in less than a year. No less than 53 different stocks appreciated 100% or more from a date when they appeared in one of the Magic Formula screens! Almost all of these appeared in one of the first 3 months of the year. 2 stocks, J. Crew (JCG) and Seagate (NASDAQ:STX), appreciated over 300% (JCG nearly 400%). 3 more delivered over 200% gains: CTC Media (NASDAQ:CTCM), Western Digital (NASDAQ:WDC), and Sierra Wireless (NASDAQ:SWIR).

It was a good year also for the MagicDiligence Top Buys portfolio, which on a comparative basis outperformed the S&P 500 by an average of 6.84% per pick in 2009, with 67% of our positions outperforming the market. This is the second consecutive year the portfolio has outpaced the benchmark (now 2 for 2). Top Buy picks included 7 of the aforementioned stocks achieving 100% or better gains during the course of 2009.

With results like this, and a long documented history of significant outperformance, investors who do not yet follow it should at least take a look at the Magic Formula Investing strategy for 2010. Few stock investing methods have consistently performed as well on a year-to-year basis, and certainly not the majority of mutual funds, index funds, or even dividend strategies which can take decades to deliver significant gains.

Disclosure: Steve owns no position in any stocks discussed in this article.

Source: A Review of Magic Formula Investing in 2009