Magic Formula Investing

May be some of you already read about this.

Magic Formula Investing Performance

Gotham Capital. they manage to achieve average return around 30% yearly. The founder, Joel Greenblatt, has shared the secret of this fund manager. He is a professor on the adjunct faculty of Columbia business school.

Joel Greenblatt

He did share his investment wisdom on how to achieve this so-called "Magic Investing". However, his techniques so far has been tested for US Stock Exchange. Whether this formula has been tested or back tested in other stock exchange (particularly Bursa Malaysia), it is not yet proven. Some may be skeptical. It is up to you whether you want to believe or not. May be you want to test it out. I believe option 2 may be more applicable for Bursa Malaysia. Anyway, risk on your own if you decided to follow this formula 

Below is the excerpt from his book, "The Little Book that Still Beats the Market" (page 140-143)

Option 1: MagicFormulaInvesting.com

Step 1

Go to magicformulainvesting.com.

Step 2

Follow the instructions for choosing company size (e.g., companies with market capitalizations over $50 million, or over $200 million, or over $1 billion, etc.). For most individuals, companies with market capitalizations above $50 million or $100 million should be of sufficient size.

Step 3

Follow the instructions to obtain a list of top-ranked magic formula companies.

Step 4

Buy five to seven top-ranked companies. To start, invest only 20 to 33 percent of the money you intend to invest during the first year (for smaller amounts of capital, lowerpriced Web brokers such as foliofn.com, buyandhold.com, and scottrade.com may be a good place to start). 

Step 5

Repeat Step 4 every two to three months until you have invested all of the money you have chosen to allocate to your magic formula portfolio. After 9 or 10 months, this should  result in a portfolio of 20 to 30 stocks (e.g., seven stocks every three months, five or six stocks every two months).

Step 6

Sell each stock after holding it for one year. For taxable accounts, sell winners after holding them a few days more than one year and sell losers after holding them a few days less than one year (as previously described). Use the proceeds from any sale and any additional investment money to replace the sold companies with an equal number of new magic formula selections (Step 4).

Step 7

Continue this process for many years. Remember, you must be committed to continuing this process for a minimum of three to five years, regardless of results. Otherwise, you will most likely quit before the magic formula has a chance to work!

Step 8
Feel free to write and thank me.

Option 2: General Screening Instructions

If using any screening option other than magicformulainvesting.com, you should take the following steps to best approximate the results of the magic formula:

• Use Return on Assets (ROA) as a screening criterion. Set the minimum ROA at 25%. (This will take the place of return on capital from the magic formula study.)
• From the resulting group of high ROA stocks, screen for those stocks with the lowest Price/Earning (P/E) ratios. (This will take the place of earnings yield from the magic formula study.) 
• Eliminate all utilities and financial stocks (i.e., mutual funds, banks and insurance companies) from the list.
• Eliminate all foreign companies from the list. In most cases, these will have the suffix “ADR” (for “American Depository Receipt”) after the name of the stock. 
• If a stock has a very low P/E ratio, say 5 or less, that may indicate that the previous year or the data being used are unusual in some way. You may want to eliminate these stocks from your list. You may also want to eliminate any company that has announced earnings in the last week. (This should help minimize the incidence of incorrect or untimely data.) 
• After obtaining your list, follow steps 4 and 8 from the magicformulainvesting.com instruction page.