Magic Formula - Joel Greenblatt

• Magic Formula to beat the market by Joel Greenblatt, a top-performing hedge fund manager since the 1980s
• A long-term investment strategy designed to buy a group of above-average companies (High return of capital) when they are available at below-average prices (low EV/Ebit)
• Earnings Yield = EBIT / Enterprise Value
• Enterprise value = Market capitalization + Total Debts + Minotiry Interest – Excess cash 
• Return on Capital = EBIT / (Fixed Assets + Net Working Capital)
• Fixed assets generally is the property, plant and equpment
• Net working capital = Receivables + Inventories – Payable 
• Formula
  
• Establish a minimum market capitalization (usually greater than $50 million).
• Exclude utility and financial stocks.
• Exclude foreign companies (American Depositary Receipts).
• Determine company's earnings yield = EBIT / enterprise value.
• Determine company's return on capital = EBIT / (net fixed assets + working capital).
• Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages).
• Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period.
• Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
• Continue over a long-term (3–5+ year) period.
•  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.
• Why it works?
1. Most investors tend to avoid buying many of the biggest winners
• Why Cheap? the near future for a company might not look quite as bright as the recent past or there’s a great deal of uncertainty about the company for one reason or another 
• It systematically avoided by both individuals and institutional investors 
2. Investors tend to sell their good stocks after they underperform for some time.
•  It’s hard to stick to a seemingly good stock that’s not working for a little while. 
3. Many Investors sell their good stocks after the market and their portfolio declined 
• It should work better in Bursa than US
• less institutional investor and hence less followers of this magic formula
• institutional investor have no mandate to buy stock meet the magic formula - which most of them is small & mid cap stocks
• retail investor is not savvy in fundamental investing - don't know how to determine a good company or a good price.
• retail investor normally relying on IB's report (who have their own interest) or listen to the rumours in the market
• retail investor influenced by greed and fear,
• Improvement on Magic Formula
• Steady income for pass few years
• Quality on earning - check the cash flow
• Opg Cash Flow close to or above net profit
• FCF positive most of the year- 10% of invested capital, 5% of revenue
• Healthy balance sheet - little & manageable debt (low risk)
• Price is well below the DCF intrinsic value (huge MOS)
• Some growth..... 
• Mr. Chong Magic Formula's Pick
• http://klse.i3investor.com/servlets/pfs/13147.jsp 
• http://klse.i3investor.com/servlets/pfs/21089.jsp  (stock picks write up at http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/blidx.jsp) 

References:

• The Magic Formula Investing Strategy kcchongnz
• http://en.wikipedia.org/wiki/Magic_formula_investing
• ROIC-Greenblatt-and-Fool-Articles
• A Reflection of My Experience in Magic Formula Investing kcchongnz