As Japan is one of the few countries I am still finding a lot of good quality undervalued companies I thought it would be interesting to see what companies the Magic Formula comes up with.
Before I get to the specific company names first a bit of background on the Magic Formula.
How the Magic Formula find investment ideas?
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 and all companies are ranked again using this combined ranking.
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 in the screener.
This means you can get a list of the best Magic Formula companies (in the countries you want to invest) with a few mouse clicks.
This is what the Japanese Magic Formula screen looks like
This is what the screen I put together looks like:
Click image to enlarge
This is what I screened for:
- Top 20% of Magic Formula (MF Rank) companies
- In Japan
- With financial statements updated in the last 6 months
- With an 30 day average daily traded value of more than $100,000
- With a market value of more than $50 million
- I then sorted the results by Magic Formula ranking (MF Rank) - the lower the Magic Formula ranking the better)
These are the best Japanese Magic Formula companies the screener came up with:
Click image to enlarge
Source: Quant Investing screener
As you can see there are quite a few interesting good quality (high ROIC) cheap (high EBIT / Enterprise value) companies included.
mixi, Inc looks interesting
For example, the best rated company mixi, Inc. (2121) is an information technology company that operates a Website for social networking services under the site name mixi.
Over the past 12 months mixi generated a very high ROIC of 224% and is also nicely undervalued with EBIT to enterprise value of 27.5%.
The Magic Formula can be improved a lot
Even though the Magic Formula is a great investment strategy you can improve its returns a lot, up to 600.5% in the testing we have done.
We tested it with 13 other ratios and, as you can see in the table below, the returns of the strategy can be substantially improved.
Click image to enlarge
Magic Formula returns when combined with a third ratio in Europe from June 1999 to June 2011.
Source: Quantitative Value Investing in Europe: What works for achieving alpha
Look at column Q1
Look at the returns in column Q1, it shows the returns generated by first selecting the best Magic Formula companies combined with the ratios in the column called Factor 2.
Best combination +783% was Momentum (600.5% improvement)
This means you could have earned the highest return of 783.3% over the 12 year period if you invested in the best ranked Magic Formula companies that also had the highest 6 month price index (share price momentum).
This is a 600.5% improvement over the best return of 182.8% you could have earned if you used only the Magic Formula to get investment ideas.
What is 6 months momentum?
Six months momentum (Price Index 6m) is calculated as follows:
Current share price / Share price 6 months ago.
It's a ratio that shows the return of a share price over the past six months. A value greater than one shows you that there's been a price increase over the period whereas a ratio less than 1 shows that there has been a price decrease.
Dividends are included (added) to the price index calculation.
You can read more about why momentum works here: 10 myths about momentum investing, squashed
Other great combinations
Other good combinations from the table above are:
- Magic Formula and 12m Price index (momentum) +472.3%
- Magic Formula and Price to Book +460%
- Magic Formula and ERP5 +384.4%
- Magic Formula and 5yr average Earnings Yield (EBIT/EV) +294.8%
How to combine the Magic Formula with 6 months momentum (Price Index 6 months)
I adjusted the above screen to incorporate 6 months momentum with the magic formula.
This is what the screen looks like:
Click image to enlarge
Source: Quant Investing screener
This is what I screened for:
- Top 10% of Magic Formula (MF Rank) companies
- Top 20% of 6 months momentum (Price Index 6m) companies
- In Japan
- With financial statements updated in the last 6 months
- With an 30 day average daily traded value of more than $100,000
- With a market value of more than $50 million
- I then sorted the results by 6 months momentum (the higher the value the higher is the company’s momentum)
These are the best Japanese 6 months momentum Magic Formula companies the screener came up with:
Source: Quant Investing screener
I hope you these screens have given you a few interesting investment ideas to research further.
Your Magic Formula analyst
PS To find Magic Formula investment ideas in the countries you invest in (for less than an inexpensive lunch for two) click here: Join today
