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Joel Greenblatt has proposed a stock screen for which he has reported enviable results. He reported an annual 30.8% return for his “Magic Formula” in his book, The Little Book that Beats the Market. Since publishing his book, this strategy has performed well, though many analysts who have followed the “Magic Formula” have not seen performance as high as 30.8% annual returns. Greenblatt’s results are particularly interesting because his picks are not subjective: they are based on a simple ranking of earnings yield (EBIT/EV) and return on capital.

How rapidly are the Magic Formula stocks added to and dropped from the list? Should an investor add many stocks at once or a few gradually, to skim the best picks over time? In order to kick the tires, I wanted to see how the list of top 50 Magic Formula stocks changes week over week. I generated the portfolio on 8.22.2011 and have updated it weekly for an entire quarter (three months ending Nov. 23, 2011). Of the 50 original Magic Portfolio stocks present, only 24 remain one quarter later:

Ticker

Status

Market Cap
($Millions)

P/E (ttm)

P/B

Beta

ENTR

Dropped 8.29.2011

319.9

5.11

1.45

2.61

MDCO

Dropped 8.29.2011

709.6

6.85

1.98

0.66

NEP

Dropped 8.29.2011

63.06

1.35

0.49

2.4

OSK

Dropped 8.29.2011

1475.91

5.02

1.08

2.54

MEDW

Dropped 9.13.2011

81.75

16.06

1.56

0.71

SUPG

Dropped 9.13.2011

131.12

7.93

1.05

1.13

KFY

Dropped 9.20.2011

762.39

12.59

1.3

1.34

NSR

Dropped 9.20.2011

1736.72

11.7

2.52

0.73

COOL

Dropped 10.11.2011

80.43

8.59

3.1

1.51

DV

Dropped 10.11.2011

2690

8.41

1.82

0.42

LRCX

Dropped 10.19.2011

4787.45

6.52

1.89

1.38

USNA

Dropped 10.26.2011

396.47

8.36

2.77

0.74

MDP

Dropped 10.26.2011

1153.86

8.78

1.48

1.65

ASTX

Dropped 11.03.2011

202.27

7.79

1.06

0.95

TRMS

Dropped 11.03.2011

49.95

2.72

0.92

0.69

LHCG

Dropped 11.03.2011

296.11

6.83

0.94

0.99

MIPS

Dropped 11.03.2011

227.4

17.12

2.92

1.31

MANT

Dropped 11.11.2011

1367.45

10.26

1.34

0.28

MNTA

Dropped 11.11.2011

883.03

4.51

2.65

1.35

PRSC

Dropped 11.11.2011

143.96

8.54

1.48

1.85

HPQ

Dropped 11.11.2011

53733.68

6.26

1.38

1.34

MED

Dropped 11.11.2011

222.44

10.38

3

1.98

STRA

Dropped 11.17.2011

1149.14

9.98

29.56

0.63

AGX

Dropped 11.17.2011

142.82

17.21

1.45

0.45

CBRX

Dropped 11.17.2011

192.86

14.83

11.33

0.65

PERI

Dropped 11.17.2011

51.47

5.5

1.7

N/A

HRB

Dropped 11.23.2011

4565.22

10.92

3.18

0.6

LTXC

Dropped 11.23.2011

322.42

5.37

1.44

2.57

PRX

Dropped 11.23.2011

1082.15

N/A

2.05

0.72

STRI

Dropped 11.23.2011

340.43

8.16

0.95

N/A

SAVE

Dropped 11.23.2011

1190.22

10.89

2.86

N/A

ACAD

Held Since 8.22.2011

73.92

3.5

2.26

2.46

AFAM

Held Since 8.22.2011

191.11

7.25

0.95

1.07

AMED

Held Since 8.22.2011

502.75

5.96

0.54

0.77

APOL

Held Since 8.22.2011

6339.53

15.84

4.68

0.19

CECO

Held Since 8.22.2011

1307.96

7.78

1.39

0.96

CPLA

Held Since 8.22.2011

505.85

8.74

2.68

0.67

CRAY

Held Since 8.22.2011

196.62

7.04

1.41

1.44

DELL

Held Since 8.22.2011

27454.98

7.95

3.27

1.39

DLB

Held Since 8.22.2011

3735.81

12.88

2.26

0.95

EGY

Held Since 8.22.2011

348.51

8.19

1.66

0.6

ESI

Held Since 8.22.2011

1967.81

6.2

22.73

0.63

GTAT

Held Since 8.22.2011

1552.6

7.98

5.98

1.32

KLAC

Held Since 8.22.2011

6163.31

7.86

2.14

1.75

KLIC

Held Since 8.22.2011

663.55

3.63

1.4

2.63

LPS

Held Since 8.22.2011

1416.24

6.54

3.21

0.97

NVMI

Held Since 8.22.2011

176.86

5.64

2.01

1.77

PDLI

Held Since 8.22.2011

831.78

8.71

8.12

0.53

PETS

Held Since 8.22.2011

219.18

12.45

2.55

0.43

PWER

Held Since 8.22.2011

807.86

6.64

2.03

2.05

TNAV

Held Since 8.22.2011

394.81

10.23

2.14

N/A

TSRA

Held Since 8.22.2011

740.47

13.09

1.03

1.38

USMO

Held Since 8.22.2011

343.01

2.99

1.46

0.83

VECO

Held Since 8.22.2011

1531.76

5.98

1.78

2.44

VPHM

Held Since 8.22.2011

1498.13

12.65

1.65

1.33

AMAT

New 8.29.2011

15000.09

7.88

1.76

1.04

MPAA

New 8.29.2011

126.77

17.25

1.07

1.02

MSFT

Added Back 9.28.2011, Dropped 9.20.2011

216435.84

9.71

3.85

1.03

GTIV

Added Back 10.4.2011, Dropped 9.28.2011

172.32

4.05

0.28

1

GNI

Added Back 10.4.2011, Dropped 9.06.2011

159.9

7.71

12.81

0.37

MDF

New 10.4.2011

196.52

7.5

2.26

0.65

CHKE

Added Back 10.11.2011, Dropped 10.4.2011

123.25

15.49

9.44

1.05

LMLP

Added Back 10.26.2011, Dropped 9.28.2011

81.59

8.53

1.99

1.43

DLX

Added Back 10.26.2011, Dropped 10.4.2011

1121.04

7.39

4.23

2.02

RTN

New 10.26.2011

15460

8.04

1.47

0.68

NBIX

New 11.03.2011

398.93

36.44

15.59

0.23

WSTG

New 11.03.2011

54.9

11.38

1.9

0.49

CPIX

Added Back 11.10.2011, Dropped 11.03.2011

111.48

23.68

1.36

1.36

MBND

New 11.11.2011

74.51

4.47

2.2

1.09

OSIR

New 11.11.2011

155.93

11.22

4.32

0.32

FRX

Added Back 11.17.2011, Dropped 10.19.2011

9314.77

8.31

1.77

0.69

UIS

Added Back 11.17.2011, Dropped 10.26.2011

741.31

11.86

N/A

3.63

TER

Added Back 11.17.2011, Dropped 11.03.2011

2289.68

7.61

1.71

1.73

NOC

Added Back 11.17.2011, Dropped 11.11.2011

13907.44

8.51

1.25

1.11

GME

New 11.17.2011

3035.11

8.25

1.03

0.68

ASYS

New 11.17.2011

81.96

3.35

0.72

2.11

VG

Added Back 11.23.2011, Dropped 10.26.2011

589.31

N/A

N/A

1.47

CMTL

Added Back 11.23.2011, Dropped 11.17.2011

722.55

12.57

1.08

0.34

SNDK

Added Back 11.23.2011, Dropped 11.17.2011

8944.66

7.01

1.39

1.74

MRX

New 11.23.2011

1856.65

12.72

2.13

1.18

NSU

New 11.23.2011

1044.79

10.39

2.38

0.33

In addition, 31 stocks that were not in the original Magic Formula portfolio were added to the list for at least one week.

Buying 50 stocks all at once on Aug. 29, 2011, or buying each stock as it entered the list, would have some impact on the portfolio’s overall attributes. The mean price-to-earnings ratio purchased for stocks in the original portfolio was 8.47, and buying all names at when they enter the list would result in a 9.26 average.

The mean price-to-book ratio would have dropped slightly from 3.30 in the 8.29.2011 portfolio to 3.16 for the portfolio assembled over the course of the quarter. The mean beta for all stocks over the quarter was 1.15, which is lower than the 1.34 average beta of the original 8.29.2011 portfolio.

The not-so-exciting conclusion to this study that the list changes gradually, and that many of the names which pop out of Greenblatt’s top 50 stocks end up popping back in. There is no overwhelming reason to pick a few names over time instead of buying 50 all at once based on the dynamics of this list. These are issues of value-averaging and market timing, but are not specific or especially relevant to Greenblatt’s Magic Formula.

Greenblatt’s prescription for trading the portfolio is to trim losers just inside of a one year holding period, and wait longer than one year to sell winners in order to reap a lower tax rate. This timeframe is appropriate for the frequency which firms add and drop from the list. It is likely that this list will consist of mostly different stocks about one year from its inception, and which point investors following this strategy would want to cycle out of old holdings and buy the very best stocks according to Greenblatt’s criteria.

Source: Greenblatt's Magic Formula Portfolio Quarterly Update