The Magic Formular
When I was on holiday recently I took the opportunity to read a book called The Little Book That Still Beats the Market by Joel Greenblatt. It was a fascinating read.
Basically, Joel Greenblatt discovered that companies that met certain criteria produced returns that were consistently far in excess of the average stock market returns. The two measures that produced the best results were companies with the highest earnings per share and companies with the largest return on capital employed. Whilst each ratio can be found independently there is no formula for combining both measures to rank companies that have the best of these two ratios. At least that was the case until Joel Greenblatt created such a ranking system himself which he called the Magic Formula. He has even created a website www.magicformula.com which lists all of the companies in ranking order. It is solely based on US shares.
Greenblatt’s strategy produced 40% p.a. returns in the early years when his fund was small. Now it is large the returns aren’t as high, but they are still 20%+ per annum.
In his book he recommends the following strategy for using Magic Formula.
Select market cap between $50m-$1 billion and, say, 30-50 shares.
Buy, say, 7 shares every quarter thus benefitting from dollar cost averaging.
Only hold each batch of 7 shares for 12 months before selling them and re-investing in to 7 different shares that meet the criteria.
I think such a strategy is almost the same as an index tracker or passive fund in that no real research is required. The system selects the shares for you. The only two things you have to decide are a) the size market cap of the shares and b) the number of shares. Apart from that the system is mechanical and bears all of the hallmarks of an index tracker fund.
However, such a system is superior to a passive fund because it has been proven to consistently beat the US stock market by a substantial margin. Index tracker funds on the other hand always underperform the market because of the effect of charges. So Magic Formula is in effect an index tracker fund plus because it is highly likely to outperform the relevant stock market index unlike an index tracker fund which you could in fact describe as an index tracker minus fund.
I am so excited about this concept that I have decided to create a second investment fund for my fund management company which will be an index tracker plus fund. The difference between our proposed fund and the Magic formula one is that ours will be based on the UK stock market as we will be producing the ranking data for UK shares.
So, if you would like to get serious about improving your investment returns why not get in touch with me? You know it makes sense.