WHAT ARE WE LOOKING FOR?
When the financial world was imploding in November, 2008, we created a portfolio of stocks using the "magic formula." We've been checking in with our stocks every three months or so, and today we'll take a final look before we create a new portfolio.
We'll be sad to bid farewell to these companies, because they've done us proud. Too bad the money we invested isn't real, or we'd be writing this from a beach in Southern France.
THE BACKGROUND
The "magic formula" strategy is outlined in The Little Book that Beats the Market , by U.S. hedge fund manager Joel Greenblatt. The formula aims to find companies that are both profitable and cheap by focusing on two measures: return on capital and earnings yield.
The higher the return on capital - which Mr. Greenblatt defines as pretax operating profit divided by the sum of net working capital and net fixed assets - the more effectively a company is using its capital to generate profit.
The higher the earnings yield - defined as pretax operating profit divided by enterprise value, or the sum of stock and debt - the more attractive the stock is from a valuation standpoint. If you can find a company that's both profitable and cheap, you're getting the best of both worlds.
OUR PORTFOLIO
In November, 2008, we asked the screener at magicformulainvesting.com to generate a list of stocks with a minimum market capitalization of $2-billion (U.S.). Next, we created a hypothetical $1-million portfolio on globeinvestor.com consisting of 20 stocks with an investment of $50,000 each.
HOW ARE WE DOING?
Just peachy, thanks.
From Nov. 18, 2008, to Dec. 31, 2009, our portfolio soared 81.6 per cent, compared with a 29.8-per-cent advance for the S&P 500 index (figures do not include dividends). What's more, 19 of our 20 stocks rose, and the one that fell - MEMC Electronic Materials - dropped less than 1 per cent.
Notable among the winners were Western Digital, up 249 per cent, Southern Copper, ahead 184 per cent, and Nvidia, up 175 per cent.
Certainly, the timing of our purchases helped. The fall of 2008 was a horrible time for stocks, with many being driven down to depressed valuations that made them prime candidates for the magic formula screener. Now that the economy is improving, these stocks have come roaring back.
Tomorrow we'll be back with a new crop of magic formula stocks.