Magic Formula Investing

Custom Magic Formula Screen

An interesting point was brought up in the Magic Formula yahoo Group, What would happen if Joel Greenblatt decides to shut down the official www.magicformulainvesting.com leaving us with no “official alternative” ? The answer, we create our own!.

Having a back up is essential to someone who relies on the magic formula as its primary screen. instead of waiting for that day, why not be prepared and have our own screen.

Criteria

In “The Little Book That Beats The Market”, Joel Greenblatt gives the reader general screening instructions to find magic formula stocks. The criteria he outlines on page 136 is as follows:

• Use Return on Assets (ROA) as a screening criterioon. Set the minimum ROA at 25%. (This will take the place for return on capital from the magic formula study.)
• From the resulting group of high ROA stocks, screen for those stocks with the lowest Price/Earnings (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.

Our free screen (opens in Internet Explorer)

There are many free stock screens online that can help screen for magic formula stocks. The best one I have found is the MSN Deluxe Stock Screener . Its easy to use and its free. A quick note, make sure to download the deluxe stock screen which requires a download. Your screen should look like this once the Deluxe Stock Screen is opened.

Criteria

Return On Capital

Joel Greenblatt our stock screen does not give the option to search for stocks using  Return On Capital, but the MSN Deluxe Screen has an option for Return On Invested Capital. (Field Name >Investment Return> Return On Invested Capital).

=======> Return On Invested Capital > 25

Earnings Yield

Unfortunately, MSN Deluxe does not have EBIT criteria but the P/E will do fine. (Field Name>P/E Ratio: Current)

=========> P/E Ratio: Current = Display Only

That’s the basic magic formula screen. By default, MSN will return the top 25 matches but that can be changed so it will display the top 200 results.

More Fields I use

Below are some fields I use to help narrow the results and eliminate the financials.

Company Basics> Industry Name> Display Only ( Industry Name=Display Only)

(Field Name >Investment Return> Return On Invested Capital) Return On Invested Capital < 75

This helps  eliminates most trusts and software companies.

P/E Ratio: Current > 5

This coincides with Greenblatt’s suggestion of screen for companies with a P/E ratio greater than 5

Two More Criteria!

Market Capitalization > 2,000,000,000 (2 billion)

The market cap can be changed to one’s individual needs. For example, assume I want to search for companies that have a market cap less than 2 billion but greater than 50 million the input would be :

Market Capitalization < 2,000,000,000 (2 billion)

Market Capitalization > 50,000,000 (50 million)

To eliminate more software companies I will also set the screen so it will exclude companies on the Nasdaq.

(Company Basics > Exchange)

Exchange = NYSE

The results are in!!!!

Here are some interesting names.

Lorillard (LO)- Cigarretts

Accenture (ACN)- has been on the magic formula for a while

Nokia (NOK) - Although an ADR, its still itneresting

Coach (COH)-

Souther Peru Company (PCU)

CF Industry Holdings (CF)

Western Digital Corp (WDC)

Graco (GGG)

Mastercard (MA)

Aeropotale (ARO)

Marvel Enterntainment (MRVL)

Kinitec Concepts (KCI)

I excluded the NYSE criteria and Microsoft (MSFT)  and Research In Motion (RIMM) appear. Microsoft has been appearing on the magic formula website and I am sure it has been climbing the ranks.

Here is the URL to the screen:

http://moneycentral.msn.com/investor/invsub/finder/finderx.asp?Query=SV1QF168Z04L25ZF140Z00S1F227Z00F168Z05L75ZF140Z04L5ZF234Z04L2000000000Z&Name=Custom%20Magic%20Formula%20Screen&Tickers=25

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© 2008 Contrarian Value Investing.