Greenblatt Sprinkles Alpha From His Magic Wand - Magic Formula Large Cap Q1 Update

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Includes: AAPL, ABBV, AET, AMGN, ANTM, BIIB, CA, CSCO, DISCA, DNB, ESRX, FOXA, GILD, GNTX, HLF, HRB, HUM, JAZZ, KLAC, KORS, MD, RHI, SNI, SPY, SWKS, TARO, TGNA, UTHR, VRSN, VVV, WCG
by: Ryan Telford

Summary

Magic Formula investing of buying “good” companies at “cheap” prices has outperformed over time.

The Large Cap version of this strategy has managed to outperform its benchmark for Q1, with 80% of the holdings increasing in value.

Nearly half of the holdings in this holding period are in pharma or health care industries.

(Credit: Pixabay.com)

Buy and hold investing, quantitative investing, portfolio investing, or strategic investing are all synonymous with systematically buying and selling stocks that pass a given criterion(a). For those that follow me on Seeking Alpha will be familiar with my preference for investing in these strategies.

Super value-investor Joel Greenblatt devised one of these particular strategies, which he refers to as Magic Formula investing. The strategy screens for high quality firms (based on a high return on capital), that are also "on sale", indicated by a low EV/EBIT value. Purchase equal dollar amounts of the 30 highest ranking stocks, hold for one year, and re-balance after the year. For a complete breakdown on this investment strategy, please read here.

Like any quantitative strategy, the testing universe in which stocks are culled plays a major role in the behaviour of the strategy. Large cap and small stocks behave very differently, and can make a difference in a stock strategy.

For Magic Formula investing, I have discussed and covered universes in the largest 20% by market cap ("Large Cap"), and also by the largest 50% by market cap ("Large & Mid Cap").

Let's see how this strategy has performed in the Large Cap universe for Q1 of 2017.

The table below shows the stocks in the Large Cap universe passing the Magic Formula screen on 01 Jan of this year, and their return over the quarter.

Ticker

Name

01 Jan 2017

31 Mar 2017

Change (%) Over Q1

Market Cap ($M)

Industry

1

GILD

Gilead Sciences Inc

$71.79

$67.37

-6.15

94,668

Biotechnology

2

UTHR

United Therapeutics Corp

$144.12

$136.93

-4.99

6,119

Biotechnology

3

TARO

Taro Pharmaceutical Industries Ltd

$105.34

$119.71

13.64

4,502

Pharmaceuticals

4

HUM

Humana Inc.

$202.19

$206.42

2.09

30,421

Managed Health Care

5

HRB

Block (H&R) Inc

$22.87

$23.15

1.21

4,862

Specialized Consumer Services

6

CA

CA Inc

$31.80

$31.76

-0.14

13,126

Systems Software

7

VVV

Valvoline Inc

$21.62

$24.32

12.47

4,408

Commodity Chemicals

8

DISCA

Discovery Communications Inc

$27.66

$28.72

3.83

11,649

Broadcasting

9

TGNA

TEGNA Inc

$21.50

$25.83

20.12

4,586

Broadcasting

10

SNI

Scripps Networks Interactive Inc

$71.24

$78.60

10.34

9,214

Broadcasting

11

CSCO

Cisco Systems Inc

$30.11

$33.72

11.98

151,825

Communications Equipment

12

AET

Aetna Inc.

$124.60

$126.71

1.7

43,515

Managed Health Care

13

HLF

Herbalife Ltd

$48.72

$58.67

20.42

4,482

Personal Products

14

AAPL

Apple Inc

$115.30

$143.72

24.65

618,035

Technology Hardware, Storage & Peripherals

15

VRSN

Verisign Inc

$76.49

$86.87

13.57

7,995

Internet Software & Services

16

KORS

Michael Kors Holdings Ltd

$42.78

$38.24

-10.61

7,059

Apparel, Accessories & Luxury Goods

17

BIIB

Biogen Inc

$263.10

$269.30

2.36

61,700

Biotechnology

18

AMGN

Amgen Inc

$146.85

$164.32

11.9

108,897

Biotechnology

19

RHI

Robert Half International Inc.

$49.24

$48.57

-1.35

6,287

Human Resource & Employment Services

20

GNTX

Gentex Corp

$19.71

$21.32

8.16

5,641

Auto Parts & Equipment

21

JAZZ

Jazz Pharmaceuticals Plc

$110.00

$145.74

32.49

6,530

Pharmaceuticals

22

SWKS

Skyworks Solutions Inc

$74.99

$98.31

31.09

13,805

Semiconductors

23

ANTM

Anthem Inc

$143.97

$166.59

15.71

37,868

Managed Health Care

24

ABBV

AbbVie Inc

$62.29

$65.46

5.09

101,752

Biotechnology

25

FOXA

Twenty-First Century Fox Inc

$28.25

$32.22

14.04

52,032

Movies & Entertainment

26

KLAC

KLA-Tencor Corp

$78.48

$95.38

21.54

12,299

Semiconductor Equipment

27

WCG

WellCare Health Plans Inc

$138.42

$139.18

0.55

6,072

Managed Health Care

28

ESRX

Express Scripts Holding Co

$69.41

$66.20

-4.62

42,417

Health Care Services

29

MD

Mednax Inc

$66.86

$69.45

3.87

6,238

Health Care Services

30

DNB

Dun & Bradstreet Corp (The)

121.94

105.77

-13.26

4,463

Research & Consulting Services

(Source: Portfolio123.com data and Author Table)

You may not help but notice that nearly half of the holdings (13 of 30) are healthcare or pharma related. Other than double digit performance from Jazz Pharmaceuticals & Taro Pharmaceuticals , this high industry concentration did not seem to skew the overall performance.

The Good

80% of the stocks in the strategy (24 of the 30) showed a positive performance, six (6) of which managed returns of 20% or greater over the quarter from varying industries. Since April 2015 Apple has had a rather volatile performance with some drawdown, so it is good to see that it has produced a good return in this period.

Semiconductor manufacturer Skyworks Solutions gets the award for top performer, breaking into 30%+ territory.

The Bad

Only 20% of the stocks lost value in the period, two (2) of which lost more than 10%; retailer Michael Kors and business services company Dunn & Brad Street .

Overall Performance

In a particularly volatile quarter in the market, the Large Cap version of the Magic Formula did relatively well. At a return of 7.78% for the quarter, it has managed to outpace its benchmark, the Russell 1000TR, which returned 5.34%. This is slightly higher than the S&P500 (NYSEARCA:SPY), which returned 5.03% over the period.

The Magic Formula had a marginally higher maximum drawdown of 2.41% compared to the benchmark's 2.25%. See the graph below.

(Returns and Graph Source: Portfolio123.com data and Author graph)

Hopefully the strategy can maintain this edge over the benchmark for the remainder of the year, time will tell.

While this strategy has returned over 15% over time (source), in recent years returns have been decreasing. The graph below shows rolling 5 year out/underperformance from the benchmark.

(Source: Portfolio123.com data and Author Graph)

After a fantastic period ending in 2013, 5 year alpha over the benchmark has steadily been dropping, and even into negative territory in period ending 2014, and again in the later half of 2015.

As nearly all investing strategies have times of outperformance balanced by periods of underperformance, is Q1 a positive sign of more consistent positive returns for the Magic Formula Large Cap strategy? Let us see.

The Mid & Large Cap version of this strategy performed quite differently over Q1 of 2017, stay tuned for an update.

Until then, happy investing.

For more on quantitative investing, be sure to follow me on SeekingAlpha.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am a user of Portfolio123.com, and have included affiliate links in the article. Should users sign-up for a paid P123 membership, I will receive a nominal commission (with no extra fee to the user).