Magic Formula

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Magic Formula

Post by TheGodson » Wed Aug 16, 2017 11:26 pm

Have any of you heard of the "Magic Formula"? Its name in itself is a bit sketchy, but after reading up on it seemed sound. Basically it screens for undervalued stocks.
Here are some links to get you up to speed if you don't know what I'm talking about: ... esting.asp ... investing/

Anyways I am on the second year of this and I'm pretty sure it hasn't beat S & P 500 last year. This year it is absolute garbage. I own 19 stocks from this magic formula. Turns out only 4 have been profitable this year so far. Only 2 have made significant money, 29% and 17%. The other 2 winners are only slightly above zero. My losers are pretty terrible. The lowest is at -65.57%! The book and other people have said you are to stick to Magic Formula for 3 to 5 years in order to realize its potential. However, I'm beginning to think about ending it early. You see, if I hold a stock for 1 year and sell I collect long term capital gains. For me that is 0%, although I may be crossing into the 15% since I recently learned that capital gains tax is extended on income tax. So even though I make like 32k a year putting me in the 15% income tax bracket if I make above $5,950 in capital gains I have to pay 15% tax on the amount that passed the $5,950 mark. (Despite my Magic Formulas suckiness my other investments have done well). I also didn't include all my overtime which probably puts me above 32k. Thoughts?

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Re: Magic Formula

Post by JoMoney » Thu Aug 17, 2017 6:10 am

It's been discussed on this board before if you search. At the end of 2010 the creator of the 'Magic Formula' created some mutual funds around the idea ... ock-f.html
Formula Investing U.S. Value Select (symbol FNSAX)
Formula Investing International Value Select (FNAAX)
Formula Investing U.S. Value 1000 (FVVAX)
Formula Investing International Value 400 (FNVAX)

Those funds were later closed/merged with other funds ran by the creators company, performance hasn't been anything special
Morningstar Chart
At a meeting of the Board of Trustees of the Trust held on October 29, 2013, the Board approved an Agreement and Plan of Reorganization (the “Agreement”) to reorganize each of the Formula Investing U.S. Value 1000 Fund and the Formula Investing U.S. Value Select Fund into the Gotham Enhanced Return Fund, each a series of the Trust. ... 6dncsr.htm
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Magic Formula

Post by cutterinnj » Thu Aug 17, 2017 6:25 am

The author has one of those cute little "books of investing" (John Bogle has one too)

I read it in 2006 and liked it. It was before I had money to invest. I planned on trying it but then never got around to it.
Glad I didn't

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Re: Magic Formula

Post by Grt2bOutdoors » Thu Aug 17, 2017 6:39 am

Do you see Warren Buffett offering up his magic formula? If you want a shot at big returns buy an Emerging makets etf or international small value etf and let it ride.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Re: Magic Formula

Post by Suppertime » Thu Aug 17, 2017 1:12 pm

Magic Formula seemed plausible, and the backtested results were amazing. So I tried the Magic Formula for 5 1/2 years from 2010 to 2016, with 30 stocks, updating 5 holdings every 2 months. I ended up with an IRR of 6.3% compared to 11.6% if I'd put the same money in the Vanguard Total Stock Market Index Fund.

You catch a lot of falling knives with the Magic Formula screen. Bad expectations lead to low PE that puts a company on the screen. Then the expectations are realized, earnings disappear, the company falls off the screen. Also, near the beginning the screen was crowded with Chinese companies, all of them frauds.

Joel Greenblatt has said the strategy wouldn't get too crowded, will continue to work, because stretches bad performance will make people quit. This may be a good time to give it a try. I'll never do it again, though.

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Re: Magic Formula

Post by nisiprius » Thu Aug 17, 2017 4:22 pm

Altough I don't know the story behind it, which is not as simple as "the funds sucked," it's worth noting anyway. Whenever I read about something like the Magic Formula, I am always suspicious when it involves an individual investing in individual stocks. If the formula is so good, why doesn't someone make it easy on us by creating a mutual fund to take care of all the details, and allow the use of more stocks than a typical retail investor can afford to buy and managed?

In the case of the Magic Formula, interestingly enough, eventually Greenblatt did create a mutual fund family that implemented the Magic Formula. The company was called Formula Investing. The funds were launched in 2012. As of 2015, none of his funds outperformed their benchmarks since their inception. All have them have been terminated, merged into other funds I think.

As I say it's more complicated because he had more than one fund, and IIRC they did something more sophisticated than just implementing the magic formula, but it was certainly not a conspicuous success. That happens quite a lot when people try out a strategy running real money, for real, in real life, in a mutual fund.
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Re: Magic Formula

Post by arcticpineapplecorp. » Thu Aug 17, 2017 7:57 pm

Welcome to the forum.

Never heard of this before. But here's some of the problems (as I see them):
BREAKING DOWN 'Magic Formula Investing'

Investors can use Greenblatt's online stock screener tool to select 20 to 30 top-ranked companies, based on their earnings yield and return on capital, in which to invest. These will all be large companies, and no financial companies, utility companies or non-U.S. companies will be included. source: ... esting.asp
1. not diversified when you could own the total market (including thousands of companies)
2. you're taking country risk (no international stocks)
3. you're taking sector risk because you're not investing in ALL sectors of the market. Instead you've excluded financials and utilities
4. top ranked companies. Great companies sometimes make lousy stocks and sometimes lousy companies make great stocks. Know what I mean?

Now that being said there are also some problems that are not the fault of the "magic" but rather, of the magician (that is you). The problem with most strategies is the investor doesn't really have the convictions to stick with his/her plan long term. What's long term? Well, longer than 2 years (your current holding period...and you want to abandon ship already!!).

You're experiencing tracking error which means your investments (in anything other than the total market) will by definition perform differently from the total market. You love that when you're beating the market, but hate it when you're losing to the market. If you can't handle tracking error, you're better off just owning the market and getting the return of the market (you can't underperform it then, unless you're bouncing in and out of the total market).

Also, maybe you didn't do your homework (known in investing parlance as "due dilligence"). If you had, you'd realize that this magic formula has underperformed the market at times, and sometimes for two years in a row (see 1995-1996 and 2007-2008 below). Funny thing is, it's never lost to the S&P for three years in a row. Now that doesn't mean it can't continue it's losing streak but next year could be the year it starts to beat the S&P500 again. And you know what? You're going to bail this year! That's what people do. They hear about a strategy that has worked in the past. Don't do their homework and bail when the going gets tough. Then they never benefit from the strategy. Brilliant!

One other thing. You're discussing certain stocks that have lost and others that have gained, etc. You really need to consider your overall portfolio's performance and not just the individual components. If you look at the individual performances of each stock how do you know if you're beating the market overall or just getting lost in the weeds?

I'm not encouraging you to continue the magic formula. It's probably not right for you (or most). There's nothing wrong with that. Someone once said it's important to know your limitations. Many here have tried different things over the years and finally realized they should have stopped playing with their money and just own the market for as little as possible. When you have that epiphany, it's a game changer. You won't agonize (as much). You'll be able to get on with your life (the important stuff) and investing will be effortless (not all this buying and selling stuff every year).

The magic formula has been provided to you. Own as diversified a portfolio as you can (sector, size, style, stock, country), have enough bonds and cash to sleep well at night/dampen volatility, invest as much as you can for as long as you can and keep expenses (including taxes) as low as you can. What could possibly be better than that? Why does everyone continue to think they're above average? Good luck. Questions?


source: ... investing/
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

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