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MagicDiligence And Magic Formula Investing 2012 Performance Review

|Includes: Apollo Education Group, Inc. (APOL), ASYS, CECO

The MagicDiligence Top Buys portfolio had a solid year in 2012. The average for all positions held during the year was a 10.2% gain, vs. a 8.2% return for a matching position of the SPY (S&P 500 tracking fund), giving us a decent 2% outperformance. 60% of our positions outperformed their respective SPY comparison. Remember that we utilize a newsletter-style portfolio instead of real money (i.e., all positions are weighted equally and averaged to calculate performance).

Our results are even better when placed head-to-head against the respective Magic Formula Investing® (NASDAQ:MFI) screen (top 50 over 50 million) for the same period. The picks recommended or renewed in 2012 outperformed their respective MFI screen benchmark by an average of 6.9% through 12/27, with 21 of the 29 positions outperforming. This marks the second year in a row that we have outperformed the underlying strategy.

We sold 4 picks early this year. 2 of them, Easylink Services and Mediware, were acquired at significant premiums of 43% and 56%, respectively, each just about a month after recommendation! The other 2, Accenture (NYSE:ACN) and Time Warner (NYSE:TWX), reached the "sell early" target price before their 1 year holding period expired.

We did pretty well at picking stocks that went up, as well. 19 of the 29 2012 picks (66%) posted positive gains from recommendation through the end of the year. Mediware and 2011 holdover USANA Health Sciences (NYSE:USNA) were the year's best picks, each appreciating 56%.

Like any portfolio, we had our losers too. The worst was GT Advanced Technologies (GTAT), down 59% on the year.

Magic Formula® Investing at Large

No beating around the bush here - this was the worst year for the MFI strategy since I started following it in 2008. To measure the performance, I took one MFI screen for each week of the year (using the top 50 over 50 million screen), averaged the performance of each stock, and compared it against the performance of the SPY fund through 12/27. Here are the results:

Only *one* week (week 47) of the MFI screen outperformed the SPY on the year. Early 2012 samples underperformed the market by as much as 12%.

This is the second year in a row the overall screen has appeared to underperform the market. In 2011, MFI outperformed in 13 of 52 weeks, and had individual samples underperform by as much as 20% early in the year. MFI was much more impressive in 2010 (41 of 52 samples outperformed with a max underperformance of just 2.4%) and 2009 (10 of 12 months outperformed with max underperform of 2.5%).

We pointed to Chinese reverse take-over frauds and home healthcare as the big drags in 2011. So what were the causes for 2012? 2 primary ones:

In the early year screens, stocks in these two sectors made up as much as 20% on some days. I believe one of the principal "simple diligence" steps a mechanical MFI investor can make is to ensure his or her picks are diversified by industry to prevent situations like this.

MagicDiligence will have some additional articles over the next week recapping the 5 best performing, 5 worst performing, and some thoughts on 2013 as it relates to the strategy.

Disclosure: Steve owns GTAT