Stocks

Magic Formula Year in Review 2008

2008 stands to end as one of the worst years for stock investing in history. As of Friday (12/26), the S&P 500 is down nearly 40% from it's close on January 2 of this year. Barring an explosive rally over the next few days, 2008 will go down as the worst year in the history of the index, which has historical data back to 1950. And it's not even close. The only year even in the ballpark is 1974, where the index dropped 29.6%. The bear market of 2002 delivered a 23% decline, and 1957 delivered a comparatively meager 13.7% decline. In historical perspective, this year was exceptional. Those still holding stocks should be commended - it takes tremendous self discipline to stay the course through this storm. For those that commanded the intestinal fortitude to buy, they should be handsomely rewarded over the next few years.

The Magic Formula screen as a whole delivered similarly poor results to MFI investors in 2008. As most readers know, MagicDiligence tracks 2 MFI screens, the top 100 stocks over 50 million market cap, and the top 50 over 2 billion. Joel Greenblatt, in The Little Book that Beats the Market, showed results that supported the claim that the lower market cap screens outperform the higher market cap screens in aggregate, and MagicDiligence's data seems to support that claim in 2008. Below is a table that shows the results of buying the entire Magic Formula screens once each month this year, and their aggregate performance against the S&P 500 (I only have data back to the middle of March):

Date Purchased50m Screen2B Screen50m vs. S&P2B vs. S&P
03/13/08-33.08%-36.83%0.06%-3.69%
04/14/08-31.87%-39.26%2.24%-5.15%
05/13/08-32.74%-39.63%4.91%-1.98%
06/13/08-33.46%-37.10%2.20%-1.44%
07/14/08-26.43%-32.10%2.55%-3.12%
08/13/08-36.47%-36.69%-4.26%-4.48%
09/15/08-31.03%-32.55%-3.61%-5.13%
10/15/08-3.19%-2.97%-0.01%0.21%
11/14/088.78%6.03%8.16%5.41%
12/15/086.00%0.34%6.67%1.01%

7 out of 10 months, the 50 million screen outperformed the S&P in aggregate, while the 2 billion screen outperformed only 3 out of 10 months. For every single month tracked, the 50 million screen delivered better returns (again, in aggregate), than the 2 billion screen. On the whole, the data correlates well to Greenblatt's study.

However, it must be mentioned that very few people are able to buy all 100 stocks in the 50 million screen at one time. Additionally, MagicDiligence's data indicates that this small cap screen is much more volatile, and much more likely to contain stocks that deliver huge drops in share price. In 2008, there were several Magic Formula stocks that effectively went all the way to $0, wiping out any investment at any price. Several others dropped 90% or more and are in danger of de-listing. Here is the dubious list:

  • Idearc (IAR) - de-listed 11/20 at $0.02/share.
  • Westwood One (WON) - de-listed 11/24 at $0.02/share
  • Breakwater Resources (BWLRF) - pink sheets at $0.08/share
  • Crox (CROX) - down over 90% to $1.21/share (from a price over $20 entering the screen)
  • Lear (LEA) - down over 90% to $1.37/share (from a price over $26 entering the screen)
  • Select Comfort (SCSS) - in serious danger of de-listing at $0.23/share (close to $4 entering the screen and over $20 less than 2 years ago)

All but Lear were on the small cap screen. These are the kinds of stocks that mechanical screens cannot warn you about, but basic research can, and one of the main reasons for starting our membership service.

On the flip side, the Magic Formula also had some success stories in 2008. Several MFI stocks were bought out at significant premiums. These included:

  • Electronic Data Systems (EDS) purchased by Hewlett-Packard (HPQ) at a 57% premium.
  • FTD Group (FTD) purchased by United Online (UNTD, another MFI stock) at a 17% premium.
  • Getty Images (GYI) purchased by Heilmann & Friedman LLC at a 36% premium.
  • HireRight (HIRE) purchased by U.S. Investigations Services LLC at a whopping 120% premium.

In fact, HIRE was one of the top performers on the screen this past year. Those who purchased this MFI stock in the March/April time frame would have collected over 100% on their investment.

In normal years, it's likely that several MFI stocks would appreciate 100% or more, but it was quite rare in this historic year. However, here are some MFI winners that appreciated 75% or more:

  • Questcor Pharmaceuticals (QCOR) - up 75% since July
  • China Sky One Medical (CSKI) - up 79% since October
  • HireRight (HIRE) - up 110% since March

There are some "lightning in a bottle" stocks that aren't listed here, such as Sucampo Pharmaceuticals (SCMP), which is up over 75% in the last few weeks but is wildly volatile (it's also down over 50% since early November, so take your pick). Still, this is a meager list. Let's hope next year it will be much longer.

The MagicDiligence Top Buys portfolio has performed solidly against the market, and the Magic Formula at large, although in real returns it has been abysmal, as have most stock portfolios. The portfolio has outperformed the S&P by 3.77%, which is a good number and better than most mutual funds. Against the Magic Formula, it has narrowly outpaced the 50 million screen and is outperforming the 2 billion screen by 4.25%. Keep in mind that, while interesting, benchmarking against the Magic Formula at large is not particularly useful, as few if any individual investors have the capability to match the returns by buying every stock on the screen for a given day.

Happy New Year, and here's to better investing results in 2009!

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Disclosure: Steve owns no stocks referenced here.

Joel Greenblatt and MagicFormulaInvesting.com are not associated in any way with this website. Neither Mr. Greenblatt or MagicFormulaInvesting.com endorse this website's investment opinions, strategy, or products. Investment recommendations on this website are not chosen by Mr. Greenblatt, nor are they based on Mr. Greenblatt's proprietary investment model, and are not chosen by MagicFormulaInvesting.com. Magic Formula® is a registered trademark of MagicFormulaInvesting.com, which has no connection to this website. The information on this website is for informational purposes only and solely represents the views and opinions of the author. No warranty is provided or implied as to the accuracy, completeness, or timeliness of this information. This information may not be construed as investment advice of any kind, nor can it be relied upon as the basis for stock trades. Alexander Online Properties LLC, the proprietor of this website, is not responsible in any way for losses or damages resulting from the use of this information. Alexander Online Properties LLC is not a registered investment advisor. All logos are trademarked properties of their respective companies.

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Comments

Posted by thetrystero on 2009-04-07 21:17:04

if i'm just starting to make investments using the MFI, should i be using recent financial statements, or pre-crash statements?

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