This Simple Stock Strategy Crushed The Market In 2013

by: MagicDiligence

For the 4th time in the 6 years we've followed it, Joel Greenblatt's Magic Formula® Investing (MFI) strategy (outlined in The Little Book that Beats the Market), clearly outperformed the S&P 500 benchmark.

To measure its performance, I took the entire "Top 50 over 50 Million Market Cap" screen at the beginning of each month and pitted the average performance of its components against the SPY ETF through the end of the year. Here are the results.

Magic Formula Investing vs. The S&P 500 in 2013

Date MFI SPY Relative Best Worst
1/2/2013 +51.47% +27.73% +23.74% NUS (+278.48%) STRA (-39.47%)
2/1/2013 +43.63% +24.13% +19.50% NUS (+236.71%) BODY (-50.56%)
3/1/2013 +43.28% +24.47% +18.81% NUS (+235.00%) MBLX (-48.57%)
4/1/2013 +36.87% +21.58% +15.29% NUS (+216.51%) BTH (-42.13%)
5/1/2013 +29.65% +15.97% +13.68% GTAT (+125.91%) MBLX (-31.89%)
6/3/2013 +18.70% +9.23% +9.47% AGX (+75.99%) DXM (-61.84%)
7/1/2013 +21.14% +10.22% +10.92% AGX (+83.49%) DXM (-60.22%)
8/2/2013 +9.79% +5.09% +4.70% AGX (+72.47%) DXM (-56.74%)
9/3/2013 +12.56% +3.68% +8.88% AGX (+58.12%) MYGN (-20.95%)
10/1/2013 +7.17% +1.99% +5.18% EBIX (+46.51%) IDCC (-21.57%)
11/1/2013 +5.54% +4.46% +1.08% ENDP (+52.56%) IDCC (-17.56%)
12/2/2013 +3.40% +4.74% -1.34% DRCO (+60.56%) MYGN (-22.24%)

Results Summary

Clearly, the Magic Formula strategy did extremely well in 2013. The strategy's composite screen outperformed the S&P 500 in 11 of 12 months, by an average outperformance of 10.8%. Considering the S&P 500 was up almost 30% last year, that is quite an impressive outperformance!

It is also a return to beating the market for MFI after two consecutive years of underperformance. You can see our prior year reviews at the links below.

Three Trends that Drove these Results

While the strategy's stocks in general performed well, there were 3 underlying industry trends that powered this year's excellent performance. MFI often screens several stocks within the same industry, so trends often play a large part in determining outcomes for the strategy.

The Failed Short Attack in Multi-Level Marketing Firms

2012 ended with hedge fund manager Bill Ackman's high profile short attack on multi-level marketing (MLM) firm Herbalife (NYSE:HLF). This presentation sent the stock down from the $50s to the low $30s, and other Magic Formula MLM firms like Nu Skin (NYSE:NUS) and USANA Health Sciences (NYSE:USNA) were dragged down with it. During the year though, the lack of any FTC action and continued profitable growth sent all three stocks soaring back to more reasonable valuations. HLF was up 168% on the year, NUS was up 228%, and USNA grew 112%.

Sequestration Resolution Leads to Rebound in Defense Stocks

After many months of uncertainty, defense spending sequestration finally became a reality in March. However, instead of hurting the "big 5" defense stocks (4 of which are Magic Formula staples), the removal of uncertainty became a catalyst. Despite, at best, mediocre business results, Northrop Grumman (NYSE:NOC) was up 72% in 2013, Lockheed Martin (NYSE:LMT) swelled 63%, Raytheon (NYSE:RTN) 60%, and General Dynamics (NYSE:GD) was up 41%.

For-Profit Education Stocks Finally Bottomed

For-profit education stocks have been part of MFI since 2010, and up until this year they had been a huge drag. Many of them suffered 60-80% declines in 2012! But we finally saw enrollment trends start to bottom late this year, and the stocks of most of these firms have begun to rebound. Capella (NASDAQ:CPLA), ITT Education (NYSE:ESI), and Apollo Group (NASDAQ:APOL), all Magic Formula stocks throughout the year, grew 136%, 92%, and 34%, respectively, during 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.