Magic Formula Investing, as described in Joel Greenblatt's The Little Book that Beats the Market, is a simple strategy, but has some caveats. First, due to the fundamental differences in business model, Greenblatt throws out bank and insurance stocks. Also, and perhaps more frustrating to some investors, is the fact that all foreign based stocks and American Depository Receipts (ADRs) are tossed out as well.
The main reason for this is that international accounting standards are, well, not standardized yet and comparing the accounting of foreign firms to domestic ones is not always apples-to-apples. Adding to the complexity is the volatility of exchange rates from foreign currencies to American dollars, further skewing results. Instead of trying to tackle these problems, Greenblatt kept things simple and just discarded them. For many investors, this makes the strategy less attractive.
Virtually every money manager and economics professor has espoused the necessity of owing at least a portion of your portfolio in foreign issues. There are several reasons for this. The main one is that several emerging economies are growing GDP at a much faster rate than the U.S., providing ample organic growth opportunities. Foreign stock mutual funds have outperformed domestic funds in nearly every time frame over the last 15 years, according to Lipper. By not owning foreign stocks, your portfolio is not optimized to take advantage of the growing world economy.
These facts caused me to raise an eyebrow when I was contacted recently by the proprietor of a new screen that was specifically developed to apply Magic Formula screening techniques to foreign stocks, particularly European based firms. The site is called Magic Formula Investing Europe, and uses the popular Thomson Reuters data service. I was able to get a look at the product and I really liked what I saw - this screen provides some very interesting opportunities overseas for those so inclined. Let's take a look at it...
Service Overview
Magic Formula Investing Europe uses MFI techniques to provide 3 different sets of screens. The screens are differentiated by the currency used in financial statement reporting: one screen for euros, one for British pounds, and another for US dollars. One nice thing about the US screen is that it includes foreign ADRs that convert their results into dollars for SEC filings. Also very useful is the extensive data provided for each stock that is screened. Unlike the official MFI screen, this one contains data like actual calculated earnings yield, return on capital, dividend yield, industry sector, 52 week price range, and more. Information like this makes it much quicker to dig up attractive investing opportunities.
Filters are also pretty good. You can filter results by minimum market cap, number of stocks per page, and even country of origin. One thing I would like to see implemented is the ability to sort by column (giving you an instant read of, for example, highest dividend yields). The developers have stressed that the project is still under development and I expect this ability to be added soon.
The annual cost is €175, mainly to cover the fees imposed by Thomson-Reuters. This works out to about $225 at current exchange rates. From personal experience, data services like Thomson are very expensive, but can also be leveraged to a large number of users. The more takers that Magic Formula Investing Europe gets, the more likely the price will be able to come down over time.
Accuracy/Correlation
No mimic MFI screen is worth it's salt if the results turned up don't correlate well with the official list. To test how accurate this screen was, I ran the top 100 stocks over 50 million market cap for US dollars and compared the results against the latest official list. 36 stocks directly matched, and 14 others have appeared in the official screen recently, giving about a 50% correlation. While this may seem low, consider also that 24 in the list were foreign ADRs, leaving 26 US stocks that have not appeared in MFI. Some of these appeared on this alternate MFI screen, so the differences can probably be chalked up to data provider and algorithm discrepancies. How the actual sausage is made is one of the oft-debated mysteries of Magic Formula Investing's "official" screen.
So, overall, the screening methodology appears to be pretty faithful to Magic Formula rules.
A Few Interesting Picks
I thought it might be interesting to list out a few stocks that do not appear in official MFI lists but may interest readers. Here is one from each screen. MagicDiligence does not explicitly recommend any of these stocks - readers should do their own research before buying, as always.
US Screen: Mercadolibre (MELI, Financial). The eBay (EBAY) of Latin America, Mercadolibre is the online auction and fixed price marketplace leader in Brazil, Argentina, and Mexico, and also runs a payments processing system called MercadoPago that is similar to Paypal. The company was growing revenues at a nearly 70% clip last quarter! Plenty of organic growth potential, but Latin America has historically been very risky politically and economically.
EU Screen: Pernod-Ricard (RI.PA, Paris Exchange). A world leader in premium brand wines and spirits, including Jameson, Chivas Regal, Ricard, and Absolut. You'll have to go off the U.S. exchanges to get this one, but alcohol providers, especially premium brand ones, have been excellent long term investments.
UK Screen: AstraZeneca (AZN, Financial). One of the world's major pharmaceutical companies, and you can pick it up as an ADR on the NYSE. Some of it's well known products include cholesterol fighter Crestor, respiratory drug Symbicort, and heartburn drugs Nexium and Prevacid. This very wide moat firm also pays an impressive 9% dividend currently. Worth a close look.
Disclosure: Steve owns EBAY
Steve Alexander
www.magicdiligence.com
The main reason for this is that international accounting standards are, well, not standardized yet and comparing the accounting of foreign firms to domestic ones is not always apples-to-apples. Adding to the complexity is the volatility of exchange rates from foreign currencies to American dollars, further skewing results. Instead of trying to tackle these problems, Greenblatt kept things simple and just discarded them. For many investors, this makes the strategy less attractive.
Virtually every money manager and economics professor has espoused the necessity of owing at least a portion of your portfolio in foreign issues. There are several reasons for this. The main one is that several emerging economies are growing GDP at a much faster rate than the U.S., providing ample organic growth opportunities. Foreign stock mutual funds have outperformed domestic funds in nearly every time frame over the last 15 years, according to Lipper. By not owning foreign stocks, your portfolio is not optimized to take advantage of the growing world economy.
These facts caused me to raise an eyebrow when I was contacted recently by the proprietor of a new screen that was specifically developed to apply Magic Formula screening techniques to foreign stocks, particularly European based firms. The site is called Magic Formula Investing Europe, and uses the popular Thomson Reuters data service. I was able to get a look at the product and I really liked what I saw - this screen provides some very interesting opportunities overseas for those so inclined. Let's take a look at it...
Service Overview
Magic Formula Investing Europe uses MFI techniques to provide 3 different sets of screens. The screens are differentiated by the currency used in financial statement reporting: one screen for euros, one for British pounds, and another for US dollars. One nice thing about the US screen is that it includes foreign ADRs that convert their results into dollars for SEC filings. Also very useful is the extensive data provided for each stock that is screened. Unlike the official MFI screen, this one contains data like actual calculated earnings yield, return on capital, dividend yield, industry sector, 52 week price range, and more. Information like this makes it much quicker to dig up attractive investing opportunities.
Filters are also pretty good. You can filter results by minimum market cap, number of stocks per page, and even country of origin. One thing I would like to see implemented is the ability to sort by column (giving you an instant read of, for example, highest dividend yields). The developers have stressed that the project is still under development and I expect this ability to be added soon.
The annual cost is €175, mainly to cover the fees imposed by Thomson-Reuters. This works out to about $225 at current exchange rates. From personal experience, data services like Thomson are very expensive, but can also be leveraged to a large number of users. The more takers that Magic Formula Investing Europe gets, the more likely the price will be able to come down over time.
Accuracy/Correlation
No mimic MFI screen is worth it's salt if the results turned up don't correlate well with the official list. To test how accurate this screen was, I ran the top 100 stocks over 50 million market cap for US dollars and compared the results against the latest official list. 36 stocks directly matched, and 14 others have appeared in the official screen recently, giving about a 50% correlation. While this may seem low, consider also that 24 in the list were foreign ADRs, leaving 26 US stocks that have not appeared in MFI. Some of these appeared on this alternate MFI screen, so the differences can probably be chalked up to data provider and algorithm discrepancies. How the actual sausage is made is one of the oft-debated mysteries of Magic Formula Investing's "official" screen.
So, overall, the screening methodology appears to be pretty faithful to Magic Formula rules.
A Few Interesting Picks
I thought it might be interesting to list out a few stocks that do not appear in official MFI lists but may interest readers. Here is one from each screen. MagicDiligence does not explicitly recommend any of these stocks - readers should do their own research before buying, as always.
US Screen: Mercadolibre (MELI, Financial). The eBay (EBAY) of Latin America, Mercadolibre is the online auction and fixed price marketplace leader in Brazil, Argentina, and Mexico, and also runs a payments processing system called MercadoPago that is similar to Paypal. The company was growing revenues at a nearly 70% clip last quarter! Plenty of organic growth potential, but Latin America has historically been very risky politically and economically.
EU Screen: Pernod-Ricard (RI.PA, Paris Exchange). A world leader in premium brand wines and spirits, including Jameson, Chivas Regal, Ricard, and Absolut. You'll have to go off the U.S. exchanges to get this one, but alcohol providers, especially premium brand ones, have been excellent long term investments.
UK Screen: AstraZeneca (AZN, Financial). One of the world's major pharmaceutical companies, and you can pick it up as an ADR on the NYSE. Some of it's well known products include cholesterol fighter Crestor, respiratory drug Symbicort, and heartburn drugs Nexium and Prevacid. This very wide moat firm also pays an impressive 9% dividend currently. Worth a close look.
Disclosure: Steve owns EBAY
Steve Alexander
www.magicdiligence.com
