What is the magic formula?
Magic Formula Investing is a rules-based, proven strategy that teaches investors a relatively simple and easy to understand method for value investing. It relies on quantitative screens of companies and stock, and over the years, the strategy has been proven to beat the stock market’s average annual returns.
Magic formula investing is a technique outlined by Joel Greenblatt in his book “The Little Book That Beats The Market”. The book does more than simply set out the basic principles for successful stock market investing, it provides a “magic formula” that is easy to use and makes buying good companies at bargain prices automatic.
Magic Formula Screening Criteria
- Joel Greenblatt used a market capitalization floor of $50 million, but I personally prefer investing in stocks with Market Cap above $100mil.
- Stocks in the financial and utility sectors are excluded.
- Earnings Yield = EBIT / enterprise value.
- Return on Capital = EBIT / (Net fixed assets + working capital)
- Rank stocks in descending order based on Earnings Yield and assign a rank number to each.
- Rank the same stocks in descending order based on Return on Capital and assign a rank number to each.
- Add the rankings and select stocks that have the lowest combined ranking score. So a company that is ranked 20th in terms of ROC and 10th highest in EY would get a better combined ranking (30) than a company that is ranked 1st in ROIC but only 50th best in EY (51).
3 SGX Listed Stocks That Fits This Criteria
Aspen Group Holdings
The group engages in the property development activities in Malaysia. The company develops residential, commercial, and integrated real estate projects. The group’s projects are currently focus around the development of Aspen Vision City. AVC will create new communities such as homes, offices, malls, schools and medical facilities and will boost creation of jobs with opening of factories and malls.
Q3 and 9M FY2018 Results Review
In 3Q FY18, the Group continued its steady pace of construction at three of the four ongoing projects namely:
Tri Pinnacle – Freehold condominium with full condo-facilities targeted for the middle class.
Vervea – Freehold shop offices complemented with business-centric features
Vertu Resort – First resort-inspired high-rise development in mainland Penang.
The group recorded a revenue of RM144.3 million, which saw yoy growth of 5%. Despite subdued market sentiments, the Group made incremental sales from its ongoing projects. As of 30 Sep18, Tri Pinnacle and Beacon Executive Suites with SOHO units located in George Town, Penang, were 84.21% and 65.64% sold respectively.
At Aspen Vision City (AVC), Vervea and Vertu Resort, both managed to improve sales to 89.43% and 70.79% respectively. Tri Pinnacle and Vervea are expected to obtain T.O.P in December 2018.
The Malaysian property market is expected to remain subdued due to oversupply in the residential sector, consumer affordability, increasing cost of living coupled with rising borrowing cost and difficulty in obtaining end financing.
To address some of these headwinds, the new government has undertaken policy and process reviews to improve governance, accountability and transparency which should boost domestic consumer and business confidence to underpin the economic growth momentum.
The northern region’s first and only IKEA store at Aspen Vision City is the subject of a RM600 million investment from IKEA Southeast Asia and comprises a built-up area of over 430,000 sq.ft. The IKEA Store is scheduled for opening on 28 March 2019 and the resultant traffic and vibrant community created is expected to enhance the value of properties at AVC.
Together with IKEA Southeast Asia, the Group has also started the ground works for the 1,000,000 square-feet regional integrated shopping centre, which is scheduled to open in 2022. The first of its kind in the Northern Region, the regional integrated shopping centre will be anchored by IKEA and will feature a rooftop garden with al-fresco dining, children’s play area and spaces for public events. Similar to other shopping centres anchored by IKEA, it will focus on community events, providing entertainment, leisure, dining and other attractions for families, friends and the community. More than just a shopping centre, it is a destination for the community.
Despite its growth prospects, the stock currently trades near its 52-week low, this is due to concerns on its sole exposure to the Penang market, which poses risk of changes in socio-political and economic landscape.
Aspen Group ranks first on the Magic Formula screener with Earnings Yield of 45% and Return of Capital at 34%.
AEM provides solutions in equipment systems; and precision components and related manufacturing services for various industries. Its flagship products are handling and test solutions catered to manufacturers in the 5G economy including microprocessors, high speed communications, IOT devices, and solar cells.
2018 has been a roller coaster ride for AEM, its share price rallied 140% in 1Q FY18 before giving back all its gains and plummeting to a low of 0.65 in Aug 18. The strong rally in Q1 was mainly due to strong demand for its Test Handlers. However, as sales from the initial ramp up phases taper off, the group issued guidance that 2H18 profit before tax could fall as much as 8.2% yoy as it expects sales seasonality to peak in Q2 and Q3.
AEM expects that the initial ramp-up phase of its equipment at its customer sites to be completed by end-FY18. The group predicts headwinds and significant volatility in earnings for FY19. For FY19, the group expects a rolling upgrade phase which could introduce significant volatility into its business. Thus far, visibility into 2019 remains dim.
That said, long term outlook remains positive as AEM is still the sole supplier of Test Handlers for its major customers. In the meantime, AEM continues to work on product extensions for its major customers which may lead to new orders in FY20 and beyond.
Its subsidiary, InspiRain will deliver its first test solution for cable testing to Huawei in FY19.
Despite its bleak near term outlook, AEM presents good long term growth as we see continued growth in the tech industry. AEM ranks 2nd in my Magic Formula screener with Earning Yield at 16.9% and Return on Capital 57%.
The Group’s principal activities comprise the production and sale of cocoa ingredient products, namely cocoa butter, cocoa powder, cocoa mass and cocoa cake.
JB Foods is one of the world’s top 10 cocoa-processing companies by production capacity. Its main processing operations are in Malaysia and Indonesia. In 2014, JB Foods total production capacity increased to 145,000 mt p.a from 85,000 mt after its acquisition of 80% stake in PT Jebe Koyo. It was a shrewd business move as not only did it increase its production capacity but also saves the group from incurring Indonesian export taxes on raw cocoa beans.
JB Foods sells its products to international trade houses and end users such as F&B and confectionery manufacturers across North and South America, Asia and Europe. Its customers includes Mars Inc, Nestle SA, Mondelez International, Hershey Co, Olam Europe and many more.
The group posted profit before tax of USD 25.2mill in 9M18, a surge of 198% yoy. EBITDA increase by 122.8% in the same period, driven by combination of higher sales volume and better processing margin. Positive operating cashflows of USD30.3 million in 9M2018, growth of 133.8%. Overall, revenue increased by 6.4% year-on-year supported by strong customer demand.
The group proposed a rights issue for the use of business expansion and working capital, which generated net proceeds of $18.8 million. As of 28 Nov, the total proceeds ($18.8mm) were fully utilised of which half ($9.4mm) were used for business expansion while the remaining were used for working capital.
Its share price has been rather volatile this year, with a trading range of $0.43-0.765 and has now settled around $0.615. JB Foods ranks 3rd on my Magic Formula screener with Earnings Yield 22.5% and Return on Capital of 17.3%.
According to magicformulainvesting.com, a website owned by Joel Greenblatt himself, it recommends a diversified portfolio – more companies leads to greater diversification, and choosing larger companies generally leads to less volatility. Eliminate any companies you do not want to own for any reason; however, you should keep at least 20-30 stocks in an effort to properly manage risk.
He suggests that each stock should be sold after one year, repeating the steps to reinvest the proceeds of securities sold. This approach should be continued over a long-term (3-5 year) period.
Does the magic formula work?
So how magic is this Magic Formula in terms of performance? This table of values is from the revised 2010 version of the book.
An investor who started with $10k using the Magic Formula would have 100x the initial investment to well over a million dollars.
Recent performance from 2012-2018, tracked by Stockopedia, shows that Magic Formula stocks performed incredibly well from 2016-2018 with UK stocks returning +150% while Developed Asia stocks returning 40% in early 2018. Magic Formula stocks could not replicate its stellar returns for the rest of 2018 as stocks decline along with the broader market.