kcchongnz blog
A Reflection of My Experience in Magic Formula Investing
A Reflection of My Experience in Magic Formula Investing
“The secret to successful investing is to figure out the value of something and then-pay a lot less”
Joel Greenblatt
I have written an article on the Magic Formula first made popular by Joel Greenblatt in the appended link below:
http://klse.i3investor.com/blogs/kcchongnz/51631.jsp
What Greenblatt did for his funds was finding good companies and bought them when they were selling cheap. This is in fact common sense in investing. He uses the return on capitals as a measure of how good a company is, and earnings yield as a benchmark to gauge if it is selling cheap. The metrics and the formula are as below.
- Earnings Yield (EY) = EBIT / Enterprise Value
- Return on Capital (ROIC) = EBIT / (Fixed Assets + Net Working Capital)
Greenblatt’s Magic Formula investing strategy outperformed the S&P500 by a wide margin for the 22 years from 1988 to 2009, with the sharp drop of the equity market in 2009 due to US sublime crisis included. It outperformed S&P 17 out of the 22 years and achieved a compounded annual growth of 23.8% as compared to the 9.6% of S&P.
The article above also explains why the strategy works and it did work even in an efficient market in US.
I copied the principle of the Magic Formula for investment in Bursa, a much less efficient market. I tried finding good companies in Bursa using high ROIC, figuring out their values with earnings yield, and tried paying a lot less to acquire them. I have written an article about my criteria for a good company and what is meant by “cheap” in my context as shown in the link below:
http://klse.i3investor.com/blogs/kcchongnz/45693.jsp
My Experience of the use of the Magic Formula
I have been using the principles of The Magic Formula picking stocks for a couple of portfolios of stocks in Bursa which were published in i3investors at the time of inception. The first portfolio as shown in Table 1 in Appendix was set up on 21st January 2013 with the prevailing return of capitals and earnings yields computed around middle of January 2013. My stock picks are shown in link below:
http://klse.i3investor.com/servlets/pfs/13147.jsp
Most of the stocks were selected with high return on capitals and Earnings yields as shown in Table 1. A ROIC of above 10%-12% would be considered as a good company, and EY > 15% is considered as selling cheap. Hence a combined score of 30 would signal a good buy meeting the Magic Formula principle.
Pantech and NTPM appear to be marginally acceptable investment base on the Magic Formula. However both appeared to have high expected growth then and NTPM has a stable and durable business. Hence even their score is not that high, they were both included in the portfolio.
A number of features were added to the two metrics of the Magic Formula intended to enhance the return of the strategy. Among them companies are preferably to have:
- Steady income for at least a few years.
- Healthy balance sheet with little or no debts
- Good cash flows from operations to confirm good quality of earnings
-
Positive free cash flows
- FCF>5% revenue preferable
- FCF>5% Invested capitals preferable
- Growth potential, preferable but best comes free
The intrinsic values of the stocks were estimated using discount cash flow analysis and the stocks only bought if the price is well below their intrinsic values, in other words, with a wide margin of safety.
The return of portfolio
After seventeen months, the return of this first portfolio is shown in Figure 1 and Table 2 in the appendix.
Figure 1: Stock returns
The followings are the salient points about the performance of the portfolio as at 27th June 2014.
- The portfolio of stocks returned an average of 88.7% for a holding period of 17 months; outperform the return of the broad market of about 18.3% by a very wide margin.
- There is not a single stock which had a negative return.
- The minimum return is 16.8% for Kumpulan Fima, and the highest 239% for Prestariang.
- There are three stocks having three-digit returns; Prestariang (239%), Pintaras Jaya (193%) and Jobstreet (103%).
Encouraged by the good results, another portfolio was set up by me at the beginning of August 2013, basically also using the principles of the Magic Formula. The portfolio only consists of two old stocks, Kumpulan Fima and Pintaras Jaya, and nine new stocks. The stock picks with detail analysis and write up are shown in the link below:
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/blidx.jsp
After 10 months returns of the stocks and the portfolio are as shown in the link here.
http://klse.i3investor.com/servlets/pfs/21089.jsp
The followings are the salient points about the performance of the portfolio after 10 months as at 27th June 2014.
- The portfolio return a total gain of 50.7% for a holding period of 10 months as shown in the link above, outperformed the broad market of 6.1% also by a wide margin.
- There is only one stock with a small negative return, at just -4.3% for Tien Wah.
- There is only another stock which underperformed the market in Haio, which return 2.6%.
- There is a multi-baggers in Datasonic with a return of 196%. And the rest are all double digit gains.
I certainly have very good experience in using the magic formula investing, ie buying good companies when they are selling cheap.
Aren’t you interested in using this proven strategy to invest for long-term in the equity market to build up your wealth and for financial freedom? Aren’t you interested in learning some fundamental investing in order to get better investing outcome?
I have been carrying on an online finance and investment course for about two months already. I can say there are many satisfying participants in my course. A number of them can already perform all those analysis and valuation mentioned above. But to me the more important thing those participants would know what to do is to avoid the lemons in the stock markets now with their knowledge in financial statement analysis.
Recently a number of i3investor forumers expressed their interest to join my course. As a result, I have decided to start a new one beginning of July 2014.
Anyone interested please contact me asap at ckc14invest@gmail.com.
KC Chong (29 June 2014)
Appendix
Table 1: ROIC and EY during portfolio inception
|
Stock |
Price |
ROIC |
EY |
Total score |
|
Kfima |
2.02 |
21.6% |
26.0% |
47.6 |
|
Pintaras |
1.56 |
29.3% |
19.5% |
48.8 |
|
ECS |
1.06 |
25.2% |
33.1% |
58.3 |
|
Plenitude |
1.85 |
12.9% |
60.0% |
72.9 |
|
Jobstreest |
1.2 |
253.0% |
14.0% |
267.0 |
|
Pantech |
0.78 |
9.1% |
12.1% |
21.2 |
|
SKPRes |
0.340 |
28.6% |
33.9% |
62.5 |
|
NTPM |
0.47 |
12.4% |
10.0% |
22.4 |
|
Kimlun |
1.25 |
22.8% |
15.9% |
38.7 |
|
Prestariang |
0.605 |
150.0% |
7.8% |
157.8 |
Table 2: Portfolio return
|
Date |
1/21/2013 |
6/27/2014 |
|
|
|
|
Stock Name |
Ref Price |
Price now |
Dividend |
Gain |
% gain |
|
Kfima |
2.02 |
2.27 |
0.08 |
0.330 |
16.3% |
|
Pintaras |
1.56 |
4.38 |
0.185 |
3.005 |
193% |
|
ECS |
1.06 |
1.37 |
0.13 |
0.440 |
41.5% |
|
Plenitude |
1.85 |
2.79 |
0.06 |
1.000 |
54.1% |
|
Jobstreest |
1.20 |
2.37 |
0.06 |
1.230 |
103% |
|
Pantech |
0.78 |
1.07 |
0.11 |
0.400 |
51.3% |
|
SKPRes |
0.34 |
0.555 |
0.035 |
0.250 |
73.5% |
|
NTPM |
0.47 |
0.835 |
0.05 |
0.415 |
88.3% |
|
Kimlun |
1.25 |
1.62 |
0.05 |
0.420 |
33.6% |
|
Prestariang |
0.605 |
1.90 |
0.16 |
1.455 |
240% |
|
|
|
||||
|
Average |
89.4% |
||||
|
FTSE Mid70 |
12294 |
14190 |
369 |
2265 |
18.4% |
|
KLSE |
1632 |
1881 |
49 |
317 |
18.3% |
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Discussions
3 people like this. Showing 21 of 21 comments
i always believed in kcchongnz - the way, the truth and the magic in bursa !! thanks kcchongnz. God bless you.
2014-06-29 18:34
for newbies: to read kcchongnz idealogy, you will win half of bursa battle !
2014-06-29 18:36
kcchongnz - seacera group berhad. needs your kind and honest opinion..
preceeded with gratitudes and thanks,
AT
2014-06-29 19:16
dearest intelligent investor - kcchongnnz minds never speaks of future or hope. he speaks of now. thanks
2014-06-29 19:19
Hi Ayam Tua, it is not about future prediction. It is about portfolio management.
2014-06-29 22:17
KC, like others, I read the above with interest. I have a few questions.
(1) The magic formula suggests that a portfolio should exclude utility and financial stocks. Can you please share with us the reasons why the magic formula is not applicable to these stocks?
(2) The performance of your portfolio is indeed impressive – Congrats! Do you follow the “Greenblatt’s ritual” in investing, i.e. accumulate 2-3 positions per month over a 12-month period, re-balance your portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark, etc.?
(3) What is the maximum level of debt in the balance sheet that is considered comfortable to investors?
(4) As per your description, the Earnings Yield = EBIT / Enterprise Value. Is the EY equivalent to the inverse of the P/E ratio? Please advise.
2014-06-29 23:15
I have include the magic formula to my excel template. Feel free to review and make use of it. http://intelligentinvestor8.blogspot.com/2014/06/magic-formula-on-financial-statement.html
2014-06-30 00:00
Posted by Intelligent Investor > Jun 29, 2014 05:01 PM | Report Abuse
Hi Mr Chong,
Do you plan to rebalance your portfolio now?
Will you plan to take some profit from the multi-baggers like Datasonic, Prestariang and Pintaras Jaya; and buy more on the laggard like Tien Wah and Haio?
I actually make use of the principles of Greenblatt magic formula to buy good companies at cheap price rather than following his quantitative approach in investing. I am a hunter rather than a farmer. I sell off those stocks which have risen fast in price and no longer having large margin of safety and buy new stocks which I think meeting my hunting criteria.
So I don't actually do the rebalancing required in Greenblatt's quantitative approach.
I have taken taken for Datasonic and Prestariang, both have risen in price too fast too soon way ahead of their fundamentals, in my opinion.
Haio is an interesting stock to look at now at the present price.
2014-06-30 00:01
Hi Mr Chong,
Thanks for your reply.
How about PTARAS? In view of the stock price risen so much on pass year, the EY is now < 15%. I am using 10-Jun-14 data (stock price 4.09) on my excel - http://intelligentinvestor8.blogspot.com/2014/06/magic-formula-on-financial-statement.html and the EY should be much lower based on latest closing price of 4.39.
Should a hunter move on from this stock and perform hunting on another context?
2014-06-30 00:06
Posted by Pak Lah > Jun 29, 2014 11:15 PM | Report Abuse
KC, like others, I read the above with interest. I have a few questions.
(1) The magic formula suggests that a portfolio should exclude utility and financial stocks. Can you please share with us the reasons why the magic formula is not applicable to these stocks?
I GUESS UTILITY IS A HEAVY ASSET KIND OF BUSINESS AND HENCE LOW ROIC. FINANCIAL INSTITUTIONS HAVE VERY DIFFERENT BALANCE SHEET STRUCTURE WITH ASSETS AND LIABILITIES DIFFICULT TO SEPARATE AND IDENTIFY. VERY ARGUABLE IN COMPUTATION OF METRICS SUCH AS INVESTED CAPITAL, ENTERPRISE VALUE ETC.
(2) The performance of your portfolio is indeed impressive – Congrats! Do you follow the “Greenblatt’s ritual” in investing, i.e. accumulate 2-3 positions per month over a 12-month period, re-balance your portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark, etc.?
THOSE ARE QUANTITATIVE APPROACH IN INVESTING. I ONLY MAKE USE THE PRINCIPLES OF MAGIC FORMULA SUCH AS HOW TO IDENTIFY GOOD COMPANIES WITH ROIC, AND CHEAP STOCKS WITH EARNINGS YIELD. SO I AM NOT FOLLOWING GREENBLLATT'S QUANTITATIVE APPROACH IN THE STRICT SENSE.
(3) What is the maximum level of debt in the balance sheet that is considered comfortable to investors?
DEBTS SHOULD NOT BE MORE THAN EQUITY.
(4) As per your description, the Earnings Yield = EBIT / Enterprise Value. Is the EY equivalent to the inverse of the P/E ratio? Please advise.
YES, EARNINGS YIELD IS THE INVERSE OF PE IF YOU ARE TALKING ABOUT JUST FOR EQUITY SHAREHOLDERS. GREENBLATT USES THE WHOLE FIRM, SO HE USES EBIT/EV AS EARNINGS YIELD WHICH WILL TAKE INTO CONSIDERATION OF DEBT HOLDERS TOO.
2014-06-30 00:10
KC, thanks for the reply. One more question, I’m interested to know how to spread your portfolio? Say your fund is RM1mil and you are buying into 10 stocks. Do you put 100k into each stock?
Clearly your investment strategy is able to consistently yield the impressive return. That cannot be due to luck or coincidences.
After “trips” to your postings, many would naturally be feeling inspired to learn more, and I think this is just scratching the surface. Be that as it may, it really changes the way we are doing things now.
I’m determined to make sure that all the pieces are there and all the engines are firing in the right direction. I look forward to participating your investment course this July.
2014-06-30 05:56
Posted by Intelligent Investor > Jun 30, 2014 12:06 AM | Report Abuse
Hi Mr Chong,
Thanks for your reply.
How about PTARAS? In view of the stock price risen so much on pass year, the EY is now < 15%. I am using 10-Jun-14 data (stock price 4.09) on my excel - http://intelligentinvestor8.blogspot.com/2014/06/magic-formula-on-financial-statement.html and the EY should be much lower based on latest closing price of 4.39.
Should a hunter move on from this stock and perform hunting on another context?
If you think the stock prices has risen too much above its fundamentals, yes move on to other stocks.
But remember EY or ROIC do not take into consideration of growth potential. I normally do not pay for growth expectation because it is just an expectation. But in Pintaras case, I think the growth potential is visible.
2014-06-30 06:22
Posted by Pak Lah > Jun 30, 2014 05:56 AM | Report Abuse
KC, thanks for the reply. One more question, I’m interested to know how to spread your portfolio? Say your fund is RM1mil and you are buying into 10 stocks. Do you put 100k into each stock?
Clearly your investment strategy is able to consistently yield the impressive return. That cannot be due to luck or coincidences.
After “trips” to your postings, many would naturally be feeling inspired to learn more, and I think this is just scratching the surface. Be that as it may, it really changes the way we are doing things now.
I’m determined to make sure that all the pieces are there and all the engines are firing in the right direction. I look forward to participating your investment course this July.
Pak Lah,
Try Kelly's Formula for your portfolio allocation which I have talked about in i3. Or you can easily goggle it.
2014-06-30 06:23
Since company with Good Business value is far and few, our job is so CLEAR.
2014-07-04 11:40
Hi KCchongnz sifu, can you kindly share how do you screen for stocks based on magic formula? as I cant find any screeners that screens for EY and ROC..
your input would be invaluable to me, as I'm a newbie in investing ..
Thanks in advance!
2015-11-13 11:43
Azura,
I don't know of any screen. May be try gurufocus. Did you email me?
2015-11-13 12:05
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Hi Mr Chong,
Do you plan to rebalance your portfolio now?
Will you plan to take some profit from the multi-baggers like Datasonic, Prestariang and Pintaras Jaya; and buy more on the laggard like Tien Wah and Haio?
2014-06-29 17:01