Magic Formula Investing Broken? Why Magic Formula Investing Has Lost Its Magic! (Greenblatt)

What do you think about the magic formula investing approach? Have you used this strategy? Do you use it to screen for ideas?

Greenblatt disclosed that he did rolling periods, not calendar years. He also stated that it would not work for years on end, sometimes. He also stated that an investor should do some research into the companies and he said to hold fewer stocks, not 50. I read the little book that "still" beats the market, so perhaps it was expanded upon more in that version of the book. It is a screening model more than a quantitative model. If someone were to buy married puts for those investments, it would have slayed the returns of the overall market.

I've seen all these mechanical formulas come and go (Dogs of the Dow etc)... They all work for a while until everyone starts using them, then the underperform and revert to the mean

2005-2020 is a too short timeframe, literally had Covid and 2008 crisis in it.

Great channel Rene. I'm a new subscriber. Looking forward to watching your content.

Well according to me, there is challenge on both value and quality side. For eg, In India, the stock prices follow earnings growth instead of earnings yield or roic. So if a company with high earnings yield earns the same eps for next 10 years it'll still remian a value stock.

You hit it on the head in this video 👏 adding a qualitative measure will greatly enhance your returns. Start with the MF list and for each company, as yourself, under current conditions, can this company sustain a good chunk of its profitability? Or was the profitability just a onetime spike? Doing this will greatly enhance your returns!

Mental Models:
1.
“NetROCI (ROIC) & Net Income Growth are the Left and Right feet empowering each other in moving the Intrinsic Compounding.”
~ Total Reset ~

2.
“Dharmic Trīni-Karmāni Value Investing：达摩三业价值投资

意：The Voliation of the Stock Market is NetROCI.

话：The Speech of the Stock Market is Net Income Growth.

作：The Deed of the Stock Market is Intrinsic Compounding & Dividend Compounding.”
~ Total Reset ~

What do you think of Greenblatt's ROC definition, as opposed to ROCE / ROIC? Do you have a preference? One take I heard is that Greenblatt's ROC combined with FCF/sales is a good moat indicator.

Great content, as usual!

Personally, I think the magic formula is a bit misunderstood. I believe it is a statistical way of exploiting the return-to-mean effect. This matches up with Greenblatt's experience that people will have poorer performance if they start to manually pick from the stock screener, i.e. the best effect can come from a seemingly lower quality stock. This is also why it makes sense to not hold longer than 1 year, since you are just hunting the return-to-mean effect. Also, Greenblatt has been very clear on that the magic formula will have periods with poorer performance. If not, everyone would be doing this. However, if you are hunting the return-to-mean effect, I would think you want a lot of volatility. I believe the period after the book came out has had lower volatility, which might be the explanation of why it has not done as well as earlier.

The problem with this investing is major tax implications. The formula is based on constant turnover. Every successful stock investor ALL recommend long term holds not just 1-3 years!

I think the year came out, it became more widely used, the formula became more widely known, and everyone essentially arbitrage this formula out of efficiency.

Magic formula site does NOT rank companies as advocated by Green--- RANKING is the magic word and action

That’s pretty much how I’ve been using the magic formula for the last few years. I use it to help find stocks, then I evaluate them myself. I also read through lists of low PE stocks, and just straight up search stock lists in alphabetical order sometimes. Very time consuming. The magic formula just gives me some stock ideas.

Greenblatt did say that the magic formula didn't always work.

Great value!!!!

Wow 😄the video I needed. When you get the list of stocks on his website. Do you have to pick exactly those stocks? or Can you run a the screener again to pick stocks according to the criteria you mentioned in this video?

Great explanation. Magic formula is helping the people who do not have any idea on stock market. I thought you would suggest another formula or extensions by filling the gaps in magic formula. It would be helpful to laymen who do not know stock market. Could you please suggest a formula?

Thanks for this video, I was also confused at why they recommend selling all the stocks after 1 year. You end up having a huge tax bill if you have large gains. I'd rather keep holding so I don't have to be forced to pay taxes on gains every year.

It’s good to look at 5 YR average ROA/ROIC and compare that to ROA/ROIC TTM (trailing twelve months). I’m surprised that the MF website has not made that change from 12 month ROIC to 5 YR ROIC.

Another thing to look at is dilution and eliminate companies that are net diluting the public shareholders.

Why should it be easy to get rich?Charlie Munger

Can anyone point me towards something that will explain efficient ways to find/filter price momentum? I know what it is, I know how to calculate it, but for MF, calculating day to day or month to month price momentum for 30 stocks is tedious at best. Looking for a way to easily sift through the initial MF stocks via price momentum by lookback periods. Thanks all

i think its been cycles and the sectors

the first thing that I would ask is if those results shown in AAII are trustworthy or not?. Since your premise that the magic formula is failing is basically that you trust in the results portraited in that web site. Honestly, if they dont show me how they applied the concept of the magic formula in their computing systems, it is very hard for me to trust in those results. In my humble view, I only trust in the data provided by the "Little book that beats the market" even if it is outdated.

Hey Rene, in your video you mentioned that 1-yr ROC isn't strong enough but rather we should ask can the company maintain strong ROC in the long term and the best filter for that is asking if the company has a strong MOAT.

My question is, if every 12 months we run the magic formula again and keep companies that have maintained a strong ROC (a criticism you had against selling all holdings after one year which I agree) and then add new ones with stronger ROCs (selling off ones that fell off the list), wouldn't that negate the reason to identify MOAT because we are continuing to revise our portfolio along high ROC companies each year? Perhaps I don't understand soemthing but would appreciate your thoughts.

Thank you

Great video that I just found now, thank you for it. Many other videos just suggest to buy whatever shows up on the MF screen. I used the MF as a screener and then did additional analysis such as ROIC over a 5-year period, super investor engagement, insider ownership, positive write-ups in the Value Investors Club, how quickly can they pay back their debt and so on. If you do this, it becomes really difficult to identify even 10 stocks from the 50 results showing up. I therefore also searched for companies over 1 billion market cap. One observation I had was that COVID resulted in finding many companies performing testing, selling COVID vaccine, sports and outdoor apparel etc.
I also share your concern with selling the shares of a company after one year, but it also adds discipline to the process and avoids making decisions due to emotions. I think an alternative could be to keep the shares of a company if it shows up on the MF screen again.
Overall, I think the approach works in principle and I also think that it is a good strategy with the current shift from the growth into the value segment and investing becoming much more dependent on intelligent stock picking than in the last years where cheap money was pumped into the market.

Not used

Fully agree with you. Having a quantitative aproach to your investments is a great way to stay calm and not become to emotional and fail due to our biasis, but you can not just simply blindly pick your stocks, because more often than not one simple look at the companys buisness and/or history, would reveal, that it had one or two good years followed by very medium to poor years.

I don't find what happened that strange. The author mentioned it does underperform during bull markets. I think that is what we have been in for most of the years since the book came out. Value investing is like that. To really make the big money from that style of investing you need a long time frame including bear markets. BTW it's my favourite type of investing.

Hey, do you do backtests yourself? I know of some interesting and quite simple strategy I'd like you to backtest and show to results if possible.
Maybe we could also tweak it a bit and make it more optimal.
It allegedly made about 26% annually on average, while limiting some risk.

Wow this guy is SMART.

Very interesting content, thank you. Besides all you said (which I agree with) I also have a problem with Greenblatt's way of using pre-tax (instead of after-tax) operating profit, i.e. EBIT instead of EBIT*(1-tax rate). I understand he wants to compare the merits of the companies irrespective of the taxes they pay. This shouldn't matter if all the companies operate in the same country (the US). However, I invest in Europe, and tax spreads within Europe is a reality. Considering two equally well-run companies A and B, A being French and B being Irish, B will reward the investor better than A does, that is a fact. So if I want to choose the company that will reward me best (as opposed to awarding medals to the managers), why shoudn't I take the tax rate into account (the result being choosing B instead of A)?

Where can I find the Buffet-Hagstorm screener?

Nice video, René. Some years ago I tried some value quant strategies (magic formula, TAM, Net Nets). I think the idea is interesting (I mean, buy a quality stock at a cheap price), but these kind of strategies (for me) are difficult to hold. It’s psicologically difficult to own companies you really don’t like. I prefer to think like a business owner and not like a statician.

An intelligent investor knows how to screen these magic formulas stocks with reading financial statements and get rid of the losers. It’s just another screening website or book that make sense in theory.

I think it’s best to create a hybrid blue book stock etf that you DCA down on to provide yourself with the best winning possibilities

I feel you are engaging in the gamblers fallacy/ sunk cost fallacy when you advise letting stocks run when you have held the for a year and not seen profit.

The desire to fiddle with quantitative strategies outputs based on subjective qualitative metrics. generally takes away their greatest strengths and that is how they bypass human irrationality and fragile temperament.

Happy investing.

I would suggest using the magic formula as a triage, then after you have a focus set of companies you further investigate them and choose a subset from it according to your research.

If you are going to writeoff a strategy after 1 YEAR. That has performed for the past 20 years. Might want to rethink what you are doing investing. Maybe Index Fund is right for you.

It beat the market last year by 18% and as the writer says it will fall short for certain years but over time beats the market.... also it's been an 11 year bull market where any for of value or fundamental investments fall short of the stupid hype stocks, this book will do well over the next decade while the market slows down

The stock market is a para mutual system just like the race track.If you have a tout at the track who predicts winners consistently then many people will bet on his picks and drive down the. winnings.The fact that the magic formula quit working after the book was published gives it away..

Correct me if I am wrong but you’ll have a harder time beating the market with the magic formula during a bull run. I think it’s really when the market overall is not doing well that you can better judge the efficiency of this method. I believe at worse it gives you a great screener, then you can use that with other methods in order to pick companies you like. Of course you have to be fair as with every change you make, you’re no longer using the formula as intended, therefore you can’t blame any failures on the magic formula at this point. I think it’s a great resource, I don’t rely 100% on it for different reasons but it’s definitely useful.

I believe value investing is intelligent investing for the long term. The challenge in speculative momentum oriented markets it is hard to find deep value particularly for good companies. Longer time periods may work better and once the speculation washes out new investors and markets fall then value strategies like the magic formula will do better. In the end the strategy is not broken but the market might be. Price discovery these days is playing the market and not based upon what companies are worth.

6%? Strong doubt in such a bull market. What are the exact parameters? (how many companies? what market caps? who said 6%?)

Underperformed in frothy markets... "This time is different" mentality will be beaten in time. Stick to a process for value, don't be jealous of frothy times of over-exuberance...

I have NOT been disappointed by my magic formula results over the last 12 months