They show the returns generated by first selecting the best Magic Formula companies (most undervalued) and then sorting them by the items in the Factor 2 column. The returns you should look at are those in column Q1. We also tested the Magic Formula investing strategy with a lot of other ratios and, as you can see in the table below, the returns of the strategy can be improved substantially. The best Magic Formula investing companies all substantially outperformed the market which returned only 30.54% over the same 12 year period.īut you can substantially improve the returns of the Magic Formula strategy Substantially better than the market - only +30.5% It did this for small, medium and large companies. Source: Quantitative Value Investing in Europe: What works for achieving alphaĪs you can see companies with the best Magic Formula rank (the best ranked companies), quintile 1 (Q1) in the above table, did a lot better than companies with the worse Magic Formula rank. These were the returns the Magic Formula in Europe over the 12 year period from June 1999 to June 2011. What returns did the Magic Formula investment strategy generate? The best ranked 20% of Magic Formula companies were put in the first quintile (Q1), the next in the second, and so on, with the 20% of companies with the worse Magic Formula ranking in the fifth quintile (Q5). For example, when testing a the Magic Formula investment strategy, the back test universe was ranked from the best to the most expensive stocks. In order to test the effectiveness of an investment strategy, we divided the back test universe into five equal groups (quintiles), according to the ratio we were testing. The portfolios were all constructed on an equal-weighted basis. This means each year the return of the portfolio (dividends included) would be reinvested (equally weighted) in the strategy the following year. Returns were compounded on an annual basis. The annual returns were calculated as the 12-month price change plus dividends received. We chose 16 June as most European companies have a December year-end and by this date all their previous year-end results would be available. The 12-year period included a stock market bubble (1999), two recessions (2001, 2008-2009) and two bear markets (2001-2003, 2007-2009).Įach year all the portfolios were formed on 16 June. It was not a good time to invest in stocksĮven thought the test period was short it was not a good time to be invested in stocks. For bankrupt companies, or companies that were taken over, returns were calculated using the last stock market price available before the company was delisted.Ĭompanies with an average 30-day trading volume of less than €10,000 were excluded. The universe excluded banks, insurance companies, investment funds, certain holdings companies, and REITS.īankrupt companies were included to avoid any survivor bias. Our back test universe was a subset of companies in the Datastream database containing an average of about 1500 companies in the 17 country Eurozone markets during our 12-year period from 13 June 1999 to 13 June 2011. Return on invested capital (ROIC) = EBIT / (net working capital + net fixed assets).Įarnings yield = EBIT / Enterprise value.īefore I show you the returns of the Magic Formula first some information on how we tested. This is how the two Magic Formula investing ratios are calculated: The Quant Investing stock screener does all this for you with the click of a mouse.Ĭompanies with the lowest combined rank (high quality companies that are undervalued) are recommended, usually the top 30 companies.Ĭlick here to get Magic Formula investment ideas where you invest The formula then ranks the universe of 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), and then sum the two ranks to give a combined score. 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). The Magic Formula finds good quality companies that are trading at an attractive price. It is also the book that got me started with quantitative investing. You most likely already know the Magic Formula investment strategy was developed by Joel Greenblatt and described in his excellent book called The Little Book that Still Beats the Market. You can also see how you can improve the Magic Formula returns from 183% to 783% by just adding one simple easy to calculate ratio. This article shows you the back tested returns of the Magic Formula investment strategy in Europe over the 12 year period from June 1999 to June 2011. Magic Formula Investing and Momentum investment strategy
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