The Best Magic Formula Stocks
Joel Greenblatt's Magic Formula Investing stock strategy delivered an amazing 30% annual return to investors over a 17 year period. However, many who have tried it in practice have been disappointed by buying into value traps, leaving them with painful losses. MagicDiligence researches Magic Formula stocks and recommends only the best of the lot.
Top Buy Picks
32% of our picks outperform the market.
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Start Your Free Trial Now!The Magic Formula Investing StrategyMagicDiligence Membership
The Little Book That Beats The Market, by Joel Greenblatt, was a milestone book in value investing. In a short 155 pages that can be read in 2 hours and understood by anyone, Mr. Greenblatt concisely lays out a simple investment strategy where stocks are picked by only 2 factors: pre-tax return on tangible capital (ROTC), and earnings yield. A high ROTC is a sign of a good company. A high earnings yield is a sign of a cheap stock. The "Magic Formula" simply ranks all U.S. stocks by both metrics, adds them together, and buys the highest ranked stocks. Simple, right? And to simplify things even more, Mr. Greenblatt advises to buy 5-7 stocks every few months, holding them for a year and then selling, replacing with new picks. He even created a website, www.magicformulainvesting.com, that lists all the current stocks by his rankings. It couldn't be more simple. But look at the returns! From
a 17 year period starting in 1988, following this "Magic Formula"
produced 30.8% annual investment returns vs. 12.4% annually for the
market at large. These unbelievable results would turn an initial investment
of $15,000 into over 1.4 MILLION DOLLARS in just 17 years!
What's The Catch?A 30% annual investment return is almost unbelievable. Even Warren Buffett's legendary Berkshire Hathaway hasn't approached such lofty returns. However, when the "Magic Formula" is applied practically, some kinks in the armor appear. Specifically, the "Magic Formula" tends to turn up some stinkers along with the flowers. The screen will uncover companies with fad products, where success is unlikely to be repeated. Some companies have such a low valuation due to financial or management problems. Still others are hanging on in a dying industry. Lastly, the strategy has a nasty habit of recommending commodity stocks at the top of the price cycle and discarding them at the bottom. Most importantly, the return on tangible capital figure is a TRAILING number. A company that has little hope of maintaining it's excellent return on capital (or has not had good ROTC numbers in the past) is not an attractive investment. You want to have a reasonable expectation of an investment maintaining attractive returns, which will be reflected in the stock price. This is known as the moat that protects a company's profits, and is the main principal used by the legendary Warren Buffett to find attractive stock opportunities. The 30.8% annual return is an average - warts and all. Imagine what the returns could be if you could
remove out the laggards from this mechanical screen?
The MagicDiligence MissionThe mission of MagicDiligence is to find Magic Formula stocks with durable competitive advantages (moats). A simple two step process accomplishes this:
When you join me, editor Steve Alexander, as a MagicDiligence Member, you get these benefits:
Unlike many newsletters, I benchmark my Top Buys against the most popular S&P 500 index fund - the S&P Depository Receipts (SPYDR, ticker SPY). Also unlike most newsletters, MagicDiligence tracks dividend earnings - an important component of stock market returns. As per the Magic Formula, each Top Buy pick will be held for one year. After that holding period, if the pick has dropped out of the Magic Formula, it will be sold and replaced. If it remains, the pick will be held for another year, and so on. Because we analyze each pick to ensure it has significant competitive advantages, our picks should drop out of the Magic Formula due to stock price increase instead of a drop on return on capital. Each stock report MagicDiligence produces is detailed, well researched, and covers the following points:
Sanity Check for Do-It-Yourself Magic Formula InvestorsIf you already follow the Magic Formula, and prefer to pick your own stocks, a MagicDiligence Membership also provides "Quick Takes" on stocks in the Magic Formula screen, as well as foreign stocks and other issues that have the characteristics of Magic Formula stocks. Each Quick Take provides a few paragraphs of background, analysis, and opinion, giving the investor more than just a list to help choose his or her portfolio. Members get 1-2 new Quick Takes every week! An Excellent Resource for Any InvestorA MagicDiligence Membership is an excellent addition to any independent investor's toolbox. Here are some ways a membership can benefit you, whatever your focus as an investor: Magic Formula Investor - Researches and recommends individual stocks on the screen, allowing you to make smart picks for your Magic Formula portfolio. Also provides frequent Quick Take reviews of MFI stocks that may interest you. Small Cap Investor - Detailed research on small cap stocks is hard to find. Large research services don't bother to cover small caps because of a relative lack of interest from their institutional clients. The Magic Formula screen is littered with excellent and cheap small cap stocks, but many of these are quite risky. By using the service's research and opinions, the small cap investor can quickly produce a list of attractive opportunities. Value Investor - The Magic Formula screen itself is in essence a value based screen. Any stocks researched are by definition cheap in a statistical sense. Adherents to the Warren Buffett school of value investing will appreciate MagicDiligence's competitive position, risks, and management research as they search for those wide moat stocks. Low Maintenance Investor - This service flags the exceptional Magic Formula stocks as Top Buys - effectively a recommendation of that stock. By following these newsletter style picks, those who want to buy great businesses at cheap prices can simply follow the recommendations and duplicate the service's returns. Members Love the ServiceMagicDiligence members love the service and the value it provides. Here are some recent comments from members: "I'm still investing with the Magic Formula, but I've added the Magic Diligence service to it, which has been wonderful. It seeks out those MF picks that have a large moat and avoids many stocks that appear in the MF list for the wrong reason... Letting Magic Diligence do the research for me has been improving my results." "Thanks for the great stock picking work! I lost a lot of money in the year I attempted to use MFI on my own with only minor vetting, and was seriously thinking of giving up on it, even though I thought the premise was sound. But I didn't feel interested or capable of doing more thorough sorting through of stocks on my own. Your service is just what I needed!" "I love your site...I am on it all the time." "First of all I want to thank you about the service you provide. I started buying stocks based on your suggestions about 3 months ago, and as of today they have had a very good return." "I do note that the companies that you have acquired since Jan have done well in light of a very difficult market, which is really encouraging" "just wanted to thanks you for your excellent website... I would easily pay double for your service (or more)."
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