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So, how did the Magic Formula® Investing (MFI) strategy perform in 2011? In a word: poorly, along with pretty much any other fundamental value strategy, and small cap indicies in general. Simply put, 2011 was not a good year to be a value investor. For one of the few times in history, most quantitative fundamental value strategies significantly trailed most of the major benchmarks.

The weekly sample screens and their performance vs. the S&P 500 can be seen at the bottom of this article. Each entry represents one of the actual "Top 50 stocks over 50 million" screen listings from the official site. The composite performance is an average of the individual performances of all 50 stocks screened on that day, including dividends. The ending date for the calculations was market close on 12/23.

The chart is interesting in that there are two distinct stories here. First of all, for much of the year the strategy badly lagged the index, in many cases by 15-20%. However, there was a slow improvement starting in the summer, and in October the screen started outperforming the S&P, which it has continued to do now for 13 consecutive weeks. Overall, the samples show MFI outperforming for 13 weeks and underperforming for 36. The average relative performance for MFI vs. the S&P was negative 9.2%.

Some observations and tidbits concerning these results and the strategy in 2011:

  • This is the first year MFI has underperformed the S&P since MagicDiligence started following it back in 2008, for either average relative performance or number of weeks outperforming.
  • Chinese reverse take-over (RTO) stocks gutted the strategy's performance in the first half. In the worst individual sample (week 9, week of March 2nd), China Northeast Petroleum (NEP) was down 59%, ZST Digital Networks (OTCPK:ZSTN) 68%, ChinaNet Online Holdings (CNET) 72%, Guanwei Recycling (GPRC) 73%, Sino Clean Energy (OTC:SCEI) 82%, New Energy Systems (OTC:NEWN) 88%, and Jiangbo Pharmaceuticals (OTCPK:JGBO) a staggering 98% as it collapsed to de-listing. Removing these RTOs would have improved the strategy's performance by about 10 percentage points a piece for the first half of those samples. MFI began filtering them out in the summer and the last record I have of one was in week #31, which, not coincidentally, matches where the strategy's performance really turned the corner.
  • Home healthcare stocks were also a drag this year. There were two on the screen the entire year, with Almost Family (AFAM) declining 61% and Amedisys (AMED) down 70%. These stocks should rebound in 2012.
  • Only one stock, Argan (AGX), delivered 100% or higher gains from any sample in 2011, reaching the target from weeks 10-13. Cubist Pharmaceuticals (CBST) was another big hit, up 88% from week 3. Usually MFI finds 5-10 stocks that double over the course of the year.

Looking forward, I expect better things from MFI in 2012. For one, the strategy's performance at the end of the year was far better, and the systematic removal of stocks with accounting concerns should prevent the dramatic effect that Chinese RTOs had in 2011. Secondly, fundamental value strategies such as this are historically reliable outperformers - two years in a row of dramatic underperformance would be unusual. Third, small caps (which constitute 75% or more of the screens below) had a bad year, with the Russell 2000 trailing the S&P by about 5 percentage points year-to-date.

Here's hoping to a better year for the strategy's fans and adherents in 2012! MagicDiligence will be there to find the best MFI stocks during the year.

Sample MFI S+P 500 Relative
Week #1 -20.2% -0.7% -19.5%
Week #2 -21.6% -1.4% -20.2%
Week #3 -19.2% -1.2% -18.0%
Week #4 -23.3% -2.3% -21.0%
Week #5 -19.8% -2.9% -16.9%
Week #6 -22.0% -4.2% -17.8%
Week #7 -28.0% -5.3% -22.7%
Week #8 -21.1% -3.3% -17.8%
Week #9 -27.1% -3.4% -23.7%
Week #10 -25.1% -4.3% -20.8%
Week #11 -20.5% 0.4% -20.9%
Week #12 -21.4% -2.7% -18.7%
Week #13 -22.0% -5.0% -17.0%
Week #14 -18.9% -5.6% -13.3%
Week #15 -16.8% -4.0% -12.8%
Week #16 -23.7% -5.2% -18.5%
Week #17 -22.2% -7.0% -15.2%
Week #18 -22.9% -6.4% -16.5%
Week #19 -23.7% -6.1% -17.6%
Week #20 -18.9% -6.1% -12.8%
Week #21 -15.2% -4.7% -10.5%
Week #22 -17.0% -4.3% -12.7%
Week #23 -12.7% -1.7% -11.0%
Week #24 -9.1% -0.9% -8.2%
Week #26 -13.1% -3.9% -9.2%
Week #27 -16.8% -6.3% -10.5%
Week #28 -14.6% -4.8% -9.8%
Week #29 -15.6% -5.3% -10.3%
Week #30 -15.6% -3.9% -11.7%
Week #31 -7.0% -0.5% -6.5%
Week #32 8.6% 11.8% -3.2%
Week #33 1.1% 4.9% -3.8%
Week #34 2.9% 6.3% -3.4%
Week #35 0.0% 2.7% -2.7%
Week #36 2.3% 4.4% -2.1%
Week #37 2.1% 5.2% -3.1%
Week #38 12.0% 7.1% 4.9%
Week #39 12.1% 8.5% 3.6%
Week #40 11.7% 9.2% 2.5%
Week #41 5.0% 3.5% 1.5%
Week #42 6.7% 3.1% 3.6%
Week #43 0.7% 0.5% 0.2%
Week #44 2.8% 0.8% 2.0%
Week #45 3.5% 1.4% 2.1%
Week #46 1.6% 0.7% 0.9%
Week #47 9.9% 7.2% 2.7%
Week #48 2.5% 0.0% 2.5%
Week #49 0.8% -1.4% 2.2%
Week #50 5.4% 2.6% 2.8%

Disclosure: Steve owns AFAM

Source: Magic Formula Investing 2011 Year In Review