"Little Book that Beats the Market"

[kyounge1956]

I've just read this book and wondered if anyone here has used the "Magic Formula" for stock selection. If so, how did the method perform during the recent stock market drop, and how well is it recovering? I also wonder how a group of stocks selected according to the formula compares in volatility to, say, an S & P index fund.

 

[MasterBlaster]

Magic Jack

I've just read this book and wondered if anyone here has used the "Magic Formula" for stock selection. If so, how did the method perform during the recent stock market drop, and how well is it recovering? I also wonder how a group of stocks selected according to the formula compares in volatility to, say, an S & P index fund.

I would like to see the risk normalized returns of the "magic Formula" versus the market. And some stats over the timeframe used for comparison.

Do you have a link to the magic formula - or is that a well kept secret ?

 

[kyounge1956]

I would like to see the risk normalized returns of the "magic Formula" versus the market. And some stats over the timeframe used for comparison.

Do you have a link to the magic formula - or is that a well kept secret ?

Here's the website. Does "risk adjusted return" mean percentage of return for each percentage of standard deviation (or per unit of other risk measure)?

 

[MasterBlaster]

Here's the website. Does "risk adjusted return" mean percentage of return for each percentage of standard deviation (or per unit of other risk measure)?

yes I suppose you could phrase it that way.

So for example I could cherry pick some volatile stocks that did well over some period and advertise my performance as beating the market. However you hold them when things go sour and you lose your shirt much more than the market.

That's the risk-reward tradeoff.

The bigger point is that every investor, every mutual fund tries to do something similar. Or at least wants to do something similar.

So what's so special about this "magic Formula" - what is it exactly ?

 

[kyounge1956]

yes I suppose you could phrase it that way.

So for example I could cherry pick some volatile stocks that did well over some period and advertise my performance as beating the market. However you hold them when things go sour and you lose your shirt much more than the market.

That's the risk-reward tradeoff.

The bigger point is that every investor, every mutual fund tries to do something similar. Or at least wants to do something similar.

So what's so special about this "magic Formula" - what is it exactly ?

Basically, a selection of large-cap stocks with a combination of high return on capital + high earnings yield, or in layman's terms, "a good business at a bargain price". That makes it a variant on value investing, yes?

 

[MasterBlaster]

How is that different than what we call value investing ?

 

[kyounge1956]

How is that different than what we call value investing ?

As I understand it, value investing only checks whether the stock is selling at a bargain price. If that's a correct description of value investing, the difference between it and the formula is that the formula also includes screening for returns. In short: value investing=buy stocks cheap; Magic Formula=buy stock in profitable companies, cheap.

Do I remember correctly that value stocks are somewhat more volatile than stocks as a whole, or am I thinking of small-cap stocks?

 

[MasterBlaster]

Price all by itself is meaningless as an indicator.

I always thought that value investing was all about buying stock in profitable companies, cheap.

maybe someone else can chime in here.

 

[Onward]

I think by value investing most people mean investing in stocks that have PE ratios lower than the market average.

 

[traineeinvestor]

I think value investing means different things to different people. At one extreme, "value" is the half of the market selling on the lowes PE ratios (in contrast to the "growth" being the other half of the market selling on the highest PEs). For other people "value" either means value by reference to all or some of the fundamentals of the underlying companies or (less commonly) by reference to comparisons with other companies. (I'm not expressing any views on these approaches to "value" investing.)

In relation to the proposal in the book, if it were that easy for anyone to "beat the market" it would be a disgrace for any investor to produce below average returns. Since by definition that cannot happen, I have difficulty accepting that any simplistic formula can reliably beat the market.

 

[travelover]

...............I have difficulty accepting that any simplistic formula can reliably beat the market.

If I had that magic formula I'd keep it to myself, invest until I was stinking rich, then burn it. I sure as heck wouldn't spend my days shilling a book.

 

[MasterBlaster]

If I had that magic formula I'd keep it to myself, invest until I was stinking rich, then burn it. I sure as heck wouldn't spend my days shilling a book.

The way to get rich is to write a book on how to get rich.

Now that's the Magic Forumla in a nutshell.

 

[freebird5825]

If I had that magic formula I'd keep it to myself, invest until I was stinking rich, then burn it. I sure as heck wouldn't spend my days shilling a book.

Uhn uuuuhhhhh If you bring candy to school, you gotta share.

 

[travelover]

Uhn uuuuhhhhh If you bring candy to school, you gotta share.

OK, Freebird - just between you and me:

Buy low and sell high

 

[Onward]

The way to get rich is to write a book on how to get rich.

Ain't that the truth.

 

[Dawg52]

OK, Freebird - just between you and me:

Buy low and sell high

I wish someone would have told me this a long time ago.

 

[freebird5825]

I wish someone would have told me this a long time ago.

OK, Freebird - just between you and me:

Buy low and sell high

I'm still immersed in the 24 waiting period to see if this advice makes sense before I make any rash decisions or...drum roll...drastic moves.

I'll update you at 1:22 PM Eastern time today. How's that?

 

[Nords]

I'm still immersed in the 24 waiting period to see if this advice makes sense before I make any rash decisions or...drum roll...drastic moves.
I'll update you at 1:22 PM Eastern time today. How's that?

With apologies to Will Rogers, remember to only buy the stocks that go up. If they don't go up then don't buy them...

 

[Onward]

And remember: if a stock breaks below X, then it is bearish. In other words, if the stock goes down, it has gone down.

 

[VirginiaTransplant]

If I had that magic formula I'd keep it to myself, invest until I was stinking rich, then burn it. I sure as heck wouldn't spend my days shilling a book.

The guy who wrote it basically followed your formula through the stinking rich part.

Google 'Joel Greenblatt.'

 

[REWahoo]

The guy who wrote it basically followed your formula through the stinking rich part.

Google 'Joel Greenblatt.'

I had no idea book sales were that lucrative...

 

[haha]

Greenblatt's Magic Formula is not off the wall, it is based on investing reality. It does appear to be highly simplified, but sometimes simple things work.

It's basically a dual screen-one for return on invested capital, the other for inverted PE. You want a high ranking on each factor.

Ha

 

[HFWR]

Do you have a link to the magic formula - or is that a well kept secret ?

We add a dash of X, and a pinch of Z...

YouTube - Tennessee Pride Sausage

If you bring candy to school, you gotta share.

Want some candy, little girl?

 

[Gone4Good]

I don't think the approach is unreasonable, and I don't think it would be much more risky then owning a basic managed fund (assuming the investor has some understanding of proper diversification). Whether it will "beat the market" is, of course, impossible to say. Things that have worked well in the past have a way of disappointing in the future. But for people who like to take the wheel and drive, this seems like a far better approach than the typical "beat the market" strategy.

 

[galeno]

SO and I are strict indexers. The most important things for us are wide global diversification and the lowest costs possible.

That said, I'm interested in using Joel Greenblatt's magic formula to pick small cap value stocks. The formula will pick companies that are earning well and are cheap. I would only use it in lieu of 10 to 20% of our portfolio. 10% of our port is in US small caps and another 10% in non-US small caps.

This is what I'm thinking. Start with say 10% of port in either VB or SCHA. Run the MF screen one a week for 30 stocks with some market cap parameter -- say 150M. Then check every single one for the MF's cap rating. Only buy the stocks with a CAPS rating of 5. Every stock you pick would eat up 1/20th of the 10% allotment so a full port would have 20 stocks.

You would sell the stock when its CAPS rating goes to 3.

The main problem with the magic formula is that there are too many transactions. If one could figure out a way to cut down drastically on those transactions, then the strategy is very viable.