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How Magic Formula Investing Performed In 2014

|Includes: ADMS, AOBC, CNVR, ESI, HLF, IQNT, LQDT, NHTC, NUS, ONE, PTIE, RGR, Strategic Education, Inc. (STRA), USNA

Every year, MagicDiligence reviews the performance of Joel Greenblatt's Magic Formula Investing (NASDAQ:MFI)screen against the S&P 500 at large, as tracked by the SPY ETF.

This is the 7th year we have tracked the comparative performance for MFI. You can see the performance of previous years at the links below.

Magic Formula Investing Vs. S&P 500, 2008-2013

Magic Formula Investing Results for 2013

Magic Formula Investing Results for 2012

Magic Formula Investing Results for 2011

Magic Formula Investing Results for 2010

Magic Formula Investing Results for 2009

Magic Formula Investing Results for 2008

Magic Formula Investing Vs. S&P 500 in 2014

While MFI had one of its best years on record in 2013, 2014 was clearly a different story. To measure performance, I took the top 50 stocks over 50 million market cap screen at the beginning of each month, measured the average performance of its components through the end of the year, and then compared that to the performance of the SPY over the same period. Here were the results:

Date MFI vs. SPY Beat Rate Best Worst
1/2/2014 +12.34% -2.22% 55.32% STRA (+119.31%) ESI (-71.53%)
2/4/2014 +17.54% -1.94% 50.00% STRA (+117.32%) ESI (-65.60%)
3/5/2014 +3.61% -8.01% 48.00% STRA (+58.65%) LQDT (-68.96%)
4/2/2014 +0.36% -10.10% 48.00% STRA (+59.78%) ESI (-66.98%)
5/7/2014 +2.71% -8.34% 48.00% USNA (+47.68%) ESI (-62.50%)
6/4/2014 +4.17% -3.83% 48.98% CNVR (+45.13%) PTIE (-58.74%)
7/2/2014 +0.96% -4.32% 52.00% NHTC (+68.88%) PTIE (-63.88%)
8/6/2014 +5.59% -2.51% 44.00% IQNT (+92.83%) PTIE (-50.37%)
9/3/2014 +3.62% +0.06% 56.00% IQNT (+58.31%) PTIE (-50.61%)
10/1/2014 +13.00% +6.66% 64.00% ESI (+129.90%) PTIE (-48.61%)
11/5/2014 +3.64% +1.50% 58.00% ONE (+50.90%) PTAXF (-48.00%)
12/3/2014 +0.84% +1.43% 66.00% ADMS (+19.30%) LQDT (-19.90%)
Three Trends That Drove Results

MFI often screens several stocks within the same industry, so overall trends often play a large part in determining outcomes for the strategy. Here are 3 in particular that helped push MFI's performance under the market's, up until late in the year.

The Gun Boom Seems To Have Run Out Of Ammo

For much of the past 5 years we've been in a "gun boom" in America, driven first by fears over the Obama Administration pushing new gun laws through, which was then rekindled by the horrid events at Sandy Hook Elementary in late 2012. Gun enthusiasts rushed to buy guns they feared would be legally restricted, leading to huge demand for firearms from 2009 through the first half of 2014. Recently, though, the boom seems to have weakened, and both Ruger (RGR) and Smith & Wesson (SWHC) - Magic Formula staples both - are down 52% and 31%, respectively, dragging the screen's performance down with them.

Multi-Level Marketing Firms (Mostly) Back In The Doghouse

After robust 2013 results, the two biggest MFI multi-level marketing (NYSE:MLM) firms, Herbalife (NYSE:HLF) and Nu Skin (NYSE:NUS), again cratered in late 2014, both down well over 40% in 2014. Combined with the gun makers, these 4 stocks were a big part of MFI's weak performance.

On the other hand, the smaller MLM's like USANA (NYSE:USNA) and Natural Health Trends (NASDAQ:NHTC) were some of the screen's better performers! The common thread seems to be poor performance and results in China for NUS and HLF, along with ongoing, high profile short attacks on both stocks (particularly HLF).

Strategy's Focus On ROIC Helped Avoid Commodities Collapse

2014 was a bad year for hard commodity markets and their stocks. Oil, copper, silver, iron ore, and to a lesser extent, gold, all fell hard in the late part of 2014, taking stocks in the mining and energy industries down with them. One of the two hurdles Magic Formula Investing imposes is ranking companies by return on invested tangible capital, making it quite difficult for stocks in these industries to get screened in (they have to be very cheap). As a result, for most of the year MFI has screened very few mining or oil companies, while the S&P 500 is over 12% energy and mining, with another 15% in industrials and utilities that can be sensitive to commodity prices. It is plain to see in the chart above that MFI began outperforming the S&P right about at the point when commodities started to nosedive in the autumn.

Best In Investing for 2015!

Despite trailing the market, every single screen sample delivered positive gains in 2014, so it was not a bad year at all for MFI investors. Over the next week I'll review the MagicDiligence Top Buys portfolio performance vs. both the S&P and the MFI screens themselves, and offer up a few thoughts for the strategy in 2015. Get these and other updates by signing up for our weekly newsletter below!

Happy New Year and all the best in investing for 2015!