Magic Formula?

by: Dark-Liquidity

In August 2011 we began monitoring the performance of the strategy described in Joel Greenblatt's book "The little book that still Beats the Market". His "Magic Formula" seeks to identify "good" businesses selling at "bargain" prices. For our performance monitoring, the stock screener on the Magic Formula Investing (MFI) Website was used to select a portfolio of 30 stocks with a market cap of 50 million dollars on the last trading day of each month. This basket of stocks was purchased on the first trading day of each month and will be held for the recommended one year period. The performance of each of the monthly basket of stocks is compared to the S&P 500 and Nasdaq indices at the end of each month in the charts below, starting with the August 1st 2011 portfolio. The stocks held in each month's portfolio and their current performances can be viewed here.

The August 1, 2011 portfolio was initiated during a steep market decline. At the end of August the MFI portfolio was down 13.26% as compared to only 6% for the Nasdaq and S&P 500 indexes. By the end of September the MFI portfolio was down a whopping 27% while the S&P had declined only 14%. Remarkably, as the general market rose the portfolio has managed to rise at double the rate of the overall market so that after a 6 month holding period the portfolio is almost back to even.

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The September 1, 2011 portfolio followed a similar path (chart shown below), initially dropping at over twice the percentage declines of the S&P 500 and Nasdaq 100 indexes but recovering in the market uptrend to match the index averages four months later.

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The October 3, 2011 portfolio was initiated during a rising market and has easily outperformed the indexes by a 2 to 1 ratio over the past 4 months rising 34% verus 16% for the SPDR S&P 500 ETF (NYSEARCA:SPY) as shown in the chart below.

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Similarly, the November portfolio is now beating the market by an impressive 3 to 1 ratio at the end of January rising over 21% versus about 7% for the SPDR S&P 500 ETF.

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The December portfolio is now beating the market by a 2 to 1 ratio while the January portfolio is about 50% ahead.

The table below shows the MFI February 1, 2012 portfolio which is typical of the MFI screening selections. You can see that about 50% of the stocks are priced less than $10 and about 10% are less than $5 which certainly explains some of the volatility when compared to the general market indices.

Purchase Date: Date Now: Portfolio Profit / Loss
2/1/2012 2/4/2012 4.94%
Ticker Company Name Purchase Price Price Now Individual Stock Profit / Loss
1 AVEO AVEO Pharmaceuticals, Inc. $13.25 $13.50 1.89%
2 AFAM Almost Family, Inc. $18.95 $20.28 7.02%
3 ASYS Amtech Systems, Inc. $10.30 $11.48 11.46%
4 APOL Apollo Group Inc $52.68 $52.41 -0.51%
5 CPLA Capella Education Company $42.54 $45.04 5.88%
6 CHKE Cherokee Inc $10.85 $11.40 5.07%
7 CBRX Columbia Laboratories Inc. $0.85 $0.81 -4.49%
8 CRAY Cray Inc. $7.49 $7.82 4.41%
9 DELL Dell Inc. $17.30 $17.66 2.08%
10 GTAT GT Advanced Technologies, Inc. $8.66 $9.44 9.01%
11 GTIV Gentiva Health Services, Inc. $7.32 $7.65 4.51%
12 ESI ITT Educational Services, Inc. $66.28 $69.82 5.34%
13 KLIC Kulicke and Soffa Industries Inc. $10.96 $11.63 6.11%
14 LMLP LML Payment Systems, Inc. $2.90 $2.80 -3.45%
15 LPS Lender Processing Services, Inc. $16.75 $18.81 12.30%
16 MDF Metropolitan Health Networks, Inc. $8.13 $8.61 5.90%
17 MNTA Momenta Pharmaceuticals, Inc. $15.74 $16.55 5.15%
18 MPAA Motorcar Parts of America, Inc. $6.49 $6.75 4.01%
19 MBND Multiband Corporation $3.30 $3.50 6.06%
20 NVMI Nova Measuring Instruments Ltd. $8.80 $8.93 1.48%
21 PDLI PDL BioPharma Inc. $6.40 $6.48 1.25%
22 PWER Power-One, Inc. $4.39 $5.28 20.27%
23 SNDK SanDisk Corporation $46.36 $47.54 2.55%
24 SAVE Spirit Airlines Incorporated $16.81 $19.21 14.28%
25 TNAV TeleNav, Inc. $7.47 $7.69 2.95%
26 USMO USA Mobility Inc $14.22 $14.95 5.13%
27 UIS Unisys Corporation $18.96 $18.33 -3.32%
28 EGY VAALCO Energy, Inc. $6.26 $6.45 3.04%
29 VECO Veeco Instruments Inc. $24.59 $27.17 10.49%
30 VG Vonage Holdings Corp. $2.55 $2.61 2.35%
SPY SPDR S&P 500 ETF $132.31 $134.57 1.71%
QQQ PowerShares QQQ Trust, Series 1 ETF $60.85 $62.05 1.97%
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The MFI screener does not appear to select a rapidly changing list of the hottest stocks. The typical number of stocks replaced each month so far has ranged from 3 to 10 stocks. Thirteen of the thirty stocks in the August 2011 portfolio are the same stocks in the February 2012 portfolio.

From this initial short time frame review of only 6 months, it appears that the MFI stock selections handily outperform the market indexes when the markets are rising but greatly underperform when the market is declining

We will continue to monitor the performances and provide a year end report in August.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.