If you found this page you most likely already know about the Magic Formula investment strategy developed by Joel Greenblatt and described in his excellent book called The Little Book that Still Beats the Market.
It is also the book that got me started with quantitative investing.
Your step by step guide
In this article I show you exactly how (step for step) you can implement the Magic Formula investment strategy in your portfolio.
We will also show you how you can improve your Magic Formula returns through a LOT of testing we have done, so keep reading.
Magic Formula ideas in your home market - not just in the USA
This article will also show you how to find Magic Formula investment ideas, not only in the USA, but in all the main markets world-wide including your home market.
First a bit of background information…
Finds quality undervalued companies
The Magic Formula helps you find good quality companies that are trading at an attractive price.
It does this by looking for companies with a high earnings yield (companies that are undervalued) and a high return on invested capital (ROIC) (quality companies).
It then ranks the companies on ROIC (where 1 is the company with the highest ROIC), and by earnings yield (where 1 is the company with the highest earnings yield).
To get the Magic Formula rank the ROIC rank and earnings yield rankings are added together.
The best ranked Magic formula company is the one with the lowest Magic Formula rank (the lower the better).
It’s all done for you
If this sounds like a lot of work do not worry - we have done it all for you. This means you can get a list of the best Magic Formula companies with a few mouse clicks.
Keep reading and I will show you exactly how.
The Magic Formula also works in Europe
You know the Magic Formula works in the USA as Joel proved in his book and on his website.
But does it also work outside the USA?
In 2012 that is exactly what we wanted to find out when we tested the Magic Formula investment strategy in Europe over the 12 year period from June 1999 to June 2011.
This is what we tested
The back-test universe was about 1500 companies in the 17 country Eurozone markets during our 12-year test period (13 June 1999 to 13 June 2011). We excluded banks, insurance companies, investment funds, certain holdings companies, and REITS.
We included bankrupt companies to avoid any survivor bias, and excluded companies with an average 30-day trading volume of less than €10 000. For bankrupt companies, or companies that were taken over, returns were calculated using the last stock market price available before the company was de-listed.
This is what we found:
Magic Formula returns in Europe from June 1999 to June 2011 by company size.
Source: Quantitative Value Investing in Europe: What works for achieving alpha
As you can see companies with the best Magic Formula rank, quintile 1 (Q1) in the above table, did a lot better than companies with the worse Magic Formula rank (Q5).
And it did this for small, medium and large companies.
The best ranked Magic Formula companies all substantially outperformed the market which returned only 30.54% over the same 12 year period.
The best Magic Formula companies did up to 152.3% better than the market.
Others have also tested the Magic Formula in Europe and it works
A lot of people also wanted to find out if the Magic Formula works in their home market and, not surprisingly, it does.
Here are some other research studies we have come across:
It does, and it was proved in 2013 by Topias Kukkasniemi in his 68 page master’s thesis The Use of Systematic Value Strategies in Separating The Winners From The Losers: Evidence From The Finnish Markets at the Lappeenranta University of Technology in Finland.
Topias tested the Magic Formula on the Finnish stock market over the 13 period from May 1997 to May 2010 and found that the strategy does outperform the market.
From 1995 to 2014 the Magic Formula definitely worked in Belgium, Luxembourg and the Netherlands as it would have given you an average yearly return of 7.7% better than the market over the 20 year test period, an impressive return.
OK so it works – how do I get Magic formula ideas
Now for the interesting part where I show you how to get Magic Formula investment ideas for your portfolio.
I have set it up for you
I have already saved a Magic Formula screen for you so all you have to do is load it.
Here is how you do it:
After loading the screener click the My templates button then click the Load a template menu item as shown below:
Then click on the Magic Formula saved screen in the Predefined templates tab.
Once you have selected the Magic Formula screen scroll to the bottom of the page and click the Load button.
Select your countries
You then have to select the countries where you would like to search for Magic Formula investment ideas.
The following countries are included in the screener: Countries included in the screener
To do this click the drop down list item below Countries and check all the countries you would like to select.
Select traded value and market value
Next you have to enter the minimum daily trading volume and the minimum market value of the companies you want to screen for.
Please note the numbers you enter are in thousands, this means if you enter $100 it is equal to $100,000.
That is all you have to do.
When you are done click the Filter button to get your Magic Formula investment ideas.
This is what you screen looks like
Dependent on what you selected your screen will look something like this:
But the Magic Formula can be improved - a lot
As I already mentioned you can improve the returns of the Magic Formula a lot, up to 600.5% in the testing we have done.
We tested the Magic Formula investing strategy with 13 other ratios and as you can see in the table below the returns of the strategy can be substantially improved.
Magic Formula returns when combined with a third ratio in Europe from June 1999 to June 2011.
Look at column Q1
Look at the returns in column Q1, it shows the returns generated by first selecting the 20% best Magic Formula investing companies combined with the ratios in the column called Factor 2.
Best combination +783% was Momentum (600.5% improvement)