Wednesday, November 2, 2016

Stock fundamental ranking and screening with Greenblatt Magic Formula

In 2005, Joel Greenblatt published a book titled "The Little Book That Beats the Market" and introduced his Magic Formula value investing method to the world. The book was supposedly wrote to teach his own children, in his Jewish family, about investment. That book became a New York Times bestseller with over 300,000 copies in print.

In 2010, the books content was updated, and its new edition is now called "The Little Book That Still Beats the Market" which you can still find in bookstores (both physical and online) now.

Joel Greenblatt is a hedge fund manager running Gotham Asset Management (formerly known as Gotham Capital) which claimed to have achieved an impressive annualized return of 40% from 1985 to 2006. He is also an adjunct professor in Columbia Business School teaching the subject of "value and special situation investing".

Greenblatt operates the Value Investors Club website for value investors around the world to freely join and share investment ideas. Another website of him is Magic Formula Investing, which is a free online stock screener (for stocks listed in USA only) based on his Magic Formula.

In his book, Greenblatt explained that in order to get above-average returns, one should buy companies with above-average return on capital at below-average prices. To find those companies, he first filters the stocks by eliminating certain industries including Utilities and Financials, which he found not applicable to his Magic Formula.

After that, he narrows down the search by filtering the companies based on market capitalization. Greenblatt suggests to apply Magic Formula to companies with market capitalization of above US$50 million. You can adjust this filter to search between large caps, mid caps and small caps targets.

Then he ranks the remaining companies based on 2 ratios:
  • Earnings Yield
  • Return on Invested Capital (ROIC)

Earnings Yield = EBIT / EV


Enterprise Value (EV) = (Market Cap + Total Debt + Minority Interest + Preferred Stock − Cash & ST Investments)

and that:

ROIC = EBIT / (Net Fixed Assets + Net Working Capital)


Net Fixed Assets = (Total Assets - Total Current Assets - Goodwill)

Net Working Capital = (Current Assets − Current Liabilities)

There are reasons why Greenblatt uses ROIC in his Magic Formula instead of ROE or ROA or other similar return ratios, and Hurricane Capital has written an article to explain about this.

At the time of writing, ValueSignals website ranked Sandridge Mississippian Trust II (NYSE:SDR) which operates in oil and natural gas sector at the top of Greenblatt Magic Formula screening.

However, SDR only scored a low 3 in Piotroski F-Score.

If you apply both the screeners of Greenblatt Magic Formula and Piotroski F-Score now, you will find magicJack VocalTec Ltd. (NASDAQ:CALL) on top of the list.

It ranks #4 in Magic Formula screening result, and scored a 7 in Piotroski F-Score test.

This combined screening is expected to produce better result than just using a single screening factor.

ValueSignals website provides a very handy and straightforward online service for systematic value investing to perform quantitative stock screening, stock comparison and stock information, currently covering as many as 33,600 stock counters listed in 44 countries around the world.

Beside Greenblatt's Magic Formula, ValueSignals website is also able to perform screening (including multifactor cross-screening) of:
The screening can be performed across all stock counters, or limited to within certain regions,  countries, industries, etc.

As a user of ValueSignals, I recommend this website to all serious value investors and fund managers to boost your stock screening and selection process.


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