Merry Christmas everyone! It’s been a tumultuous year for me as I’ve moved from San Diego, CA to Fort Worth, TX. Why would I do such a thing? Not because home prices in FW are about half of what they are in San Diego (although that’s nice too). It’s all for the love of a good woman. The transition has been fairly smooth, and all is calm, all is bright this Christmas Morning, except for my Magic Formula Portfolio. With this experiment pushing three years in, my portfolio is in the red, trailing FAR behind the S&P 500 index.
Remember, I started out with $60,000.
When I started this blog in 2017 I had big plans. The central plan was to verify that the Magic Formula works. While so doing, I would write loads of blog posts about it, attracting attention as people realized that normal retail investors could profit greatly from the information contained in Joel Greenblatt’s book. Advertising revenue from my blog would feed additional investments in MF stocks, generating more articles, profits, and I even wanted to interview Mr. Greenblatt on some of the finer points of his book.
Obviously that hasn’t worked out. I’ve been following the strategy to a T, but my enthusiasm has faded. I’m going through the motions. I barely write any posts except these sad updates. If things continue as they have, this blog will at best be a warning NOT to follow the Magic Formula Investing strategy. The only plus is that, following an industry-wide trend, Vanguard is eliminating transaction fees in its brokerage accounts, making it less painful to make all the trades involved in following the Magic Formula.
Merry Christmas and Happy New Year!
I have been doing reading that over the past decade that growth has out beat value. If this is the case, this strategy will only work when the value is concerned. I think when a recession hits and investors go back to looking at fundamentals, I will use this strategy. Thanks for doing this blog. Sorry, it is not working and I would like to know what you think about what I have read.
Hello Shane,
I just turned on comments and, congratulations, you’re the first one! As for a best time to follow this strategy, I’m not sure if I read this in Greenblatt’s book or in an interview with Greenblatt from a few years ago, but he claims that the formula outperforms the market best in bull markets, but that it also will outperform the market in ANY market. Supposedly he has the data to back it up but my experience of following his formula to a T has not yielded very good results.
The edition of his book I read had a forward from 2010. At this point, value investors were loading up on stocks after the 2008 crash. But over the last decade, I think this strategy finally saw its weakness. Your test proves that growth is destroying this strategy. With the stock market receding over the last couple of weeks, I’m looking forward to seeing if the value starts winning again.
Hi Andrew,
Thanks for sharing this info! If you hold onto stocks that are still in the list after one year, do you rebalance? Or do you accept the change in price of the stock and do you keep it unbalanced in your portfolio?
Hop to hear from you
All the best
Wouter
Hi Wouter,
I rebalance, which is easier than ever due to commission-free trades. I wrote a very short article on this. Greenblatt’s Formula definitely calls for the stocks to be held in roughly equal amounts so that’s what I try to do.
Thanks for visiting and best of luck to you.
andrew
Hi Andrew,
Thanks for your reply! Yes it seems to be a smart way forward to rebalance the stocks still in the list after one year.
The other issue you mentioned in your article somewhere in 2017 was that some mfi stocks in the list seem to have a N/A value for the PE in Google stocks or yahoo finance. This feels uncomfortable … because we hope to buy stocks that are cheap AND do earn money.. so not losing money.
MD and DLX are examples of these stocks in the current list. Did you find any explanation for this ? The quarter data seem up-to-date, so what should we do, avoid these stocks or trust the twist the magicformula gives on the calculations so that these stocks are very cheap in the end…?
Hope to hear from you!
All the best,
Wouter
Hi again Wouter,
Did you see my last response? Sometimes I’m not so sure they’re using the latest quarterly data. You either trust the screener and buy it no matter what or you pick another stock from the screener that has a P/E ratio. I generally have not picked stocks that are not profitable but I haven’t been consistent. I wish I could give you a better answer on this but it’s one of the most worrying aspects of this strategy and Greenblatt doesn’t really address it in the book (correct me if I’m wrong).
andrew
Hi Andrew,
What do you mean by your last response..? The statement that you think the quarterly data is not up-to-date sometimes at MFI?
I did check it today and it seems to be consistent with yahoo finance data on the latest quarter data. I don’t think such a basic mistake could occur on MFI website.. but you never know.
I also checked on yahoo finance other metrics than the plain PE ratio and that seems rather hopeful. In the book Greenblatt shows that he uses EBIT/enterprisevalue instead of the simple Earning yield which is E/P. If you check the data on yahoo on enterprisevalue/EBITDA.. (see tab statistics) you find that almost all the current stocks on the list are around a value of 5 positive. So due to tax or debt or other incidental issues the difference could Occur. I am not sure this is comforting enough , but on the other hand one should not try to cherry pick in whatever way from the list because Greenblatt showed earlier that the ones looking the ugliest may be the ones that perform best (so eg the ones with the negative PE..).
I am looking forward to your view on this!
Best wishes,
Wouter
Hi Wouter,
Thanks for looking into this more. On the MFI FAQ page, it says: “Over the last 30+ years we have seen many studies that demonstrate that “value” strategies-such as buying stocks with low price/earnings (P/E) ratios can outperform the market averages. In the case of the Magic Formula system, we are screening for stocks with low P/E ratios (“cheap stocks”) that also achieve high returns on capital (“good companies”). We then make some slight accounting adjustments to these commonly used ratios in order to be more accurate for comparison purposes across various companies.”
It doesn’t say what those adjustments are exactly but I guess they could account for some of the discrepancies we’ve both seen. I have invested in some of these negative P/E companies, most recently LTRPA (Trip Advisor), partly because I didn’t notice the negative P/E at the time! But in the cases where I chose not to invest in one of these, I wouldn’t call it cherry picking, because I instead chose another MFI stock taken from the screener. Greenblatt intended a certain amount of this, which is why the screener allows you to set the Minimum Market Cap, and the number of results (30 or 50). My portfolio has always been 30 stocks taken directly from the screener. You make a very good point however, and now I’m more inclined to say, “in for a penny, in for a pound” and just blindly choose whatever shows up even it doesn’t make sense to me. But one more thing regarding cherry picking, consider this: let’s say you have 5 stocks you are replacing today. You run the screener. There are 15 stocks among the top 30 on the screener that you don’t already have in your portfolio. Which ones do you choose? The stocks are listed in alphabetical order, not in order of which ones you’re supposed to choose first to last. My point is, there is always going to be an element of user preference even if you try to follow the Book as closely as possible.
Hi Andrew,
Thanks for your reply again. You’re right the website states that studies have shown that low P/E investing works over time.. but they don’t state that they exactly use the low P/E. They use actually a similar but better value for price… a high EBITDA/EnterpriseValue, which most of the time corresponds well with low P/E stocks, I think 90% of the time. But in special cases, wiht debt issues or incidental taxes the P/E can be negative but still the company can be an interesting investment because the P/E is blurred by these external effects.. I suppose of course. I’m also just best guessing in this matter, but it seems to make sense.
Your next point about cherry picking. You mentioned you sometimes didn’t choose a stock with a negative P/E and chose another one. Actually I would call that cherry picking because you leave a stock because it seems to look ugly. I try to avoid that , but I admit it is difficult. Also the point about the list and the alphabetic order is easy to avoid. The 50 stocks is an option if you want to go for a larger nr of stocks in your portfolio, because of lower volatility.. same point with larger market cap, you will also get a less wild ride. But how would you choose the few stocks you want to add from the list from 30 stocks. I just run a random number generator and pick the stock from the list with the corresponding number. If I have that stock already I run it again…
Then all cherry picking can be avoided. It’s up to you of course. But in the article below, a small study of mr Greenblatt is cited in which he stresses the importance of random picking from the list. The study is only about a timeline of 2 years.. which in my opinion could be to small for an honest comparison, but still , you could argue that random picking from the list is best..
https://seekingalpha.com/article/2816285-be-a-value-investor-without-doing-the-work-the-magic-formula
I look forward to your view on this,
Best regards,
Wouter
Your point is well taken Wouter, and I think you’re right. I’m going to start choosing randomly from the list starting with my next purchase in June.
Thank you,
Andrew
Hi Andrew,
Yeah maybe that is better, I also confused though .. and would have been better of with a low cost index fund until now… So I am not a professional investment advisor either and just hope to live through the great rotation towards value in the coming years 😉
Let’s follow each others investment experiences and keep in touch to be as informed as possible!
Good luck!!
Cheers,
Wouter
Are you including dividends also? It will be instresting to see dividend adjusted return also.
Hello Keval,
Yes, dividends are included in the return of my Magic Formula Portfolio.
Thanks,
andrew
Hello guys, I have just found this page, very happy to see there are some magic formula testers across the world 🙂 Finished the book not long ago. Starting with 20k GBP.
I will take my time to read the whole blog, i am about to start my portfolio. These are not easy times definitely but hopefully, leaving emotions aside for a minimum of 5 years, there will be benefits to reap.
I will probably cherry pick the stocks from the website, just looking at the sector in which the company operates. Will buy 3 stocks a month, over a 10 months period, in year 1.
Hi JT,
Thanks for reading. As for cherry picking, I will say the screener is useful for identifying potentially good values on stocks you were already interested in. For example, if you’re a believer in dividend stocks such as the Dividend Aristocrats and want to buy them when they seem to be on sale, I see that AbbVie (ABBV) shows up on the screener this morning.
Take care,
andrew
I noticed only some articles have a comment section which is why I’m writing here.
From your last post:
“Let’s compare that with the State Street Global Advisors S&P 500 ETF (SPY), which is now trading for $283.94. I started this experiment a little over three years ago, when the SPY was at 231.51. This website is turning into an advertisement for buying index funds or ETFs, but if you would have invested in the SPY back then, even with all the Coronavirus turmoil you would be ahead nearly 23%.
On the other hand, my Magic portfolio, which started out at $60, 000, has lost over 29 percent of its value!”
This definitely hurts, still aligned to the worst case scenario I read in the book (3 years in a row of under performing was the record i think) but wow. From -23% to +29% is a massive jump. I recently have watched another Magic Formula clip, from another investor. She started 1 year ago, and in year 1 her portfolio lost 11%.
We really need to put emotions aside..
I’ve recently finished reading the book and am interested to get started with the approach and looking online for any resources or results from real people instead of just back tests. Your website is a true find.
1. What is your market cap selection from the screener?
2. Why are comments not available on your latest portfolio update page?
Hi Varun,
I use market cap 50.
The comments were not available because I simply forgot to turn them on. Thanks for notifying me, and good luck!
andrew