Disclaimer: This article is for informational and educational purposes only. Do not interpret anything below as financial advice. Always do your own research & speak to a financial professional before making investment decisions.
Time for another Magic Formula portfolio update. I’m excited for this one as it marks just over a year since I started my own version of Joel Greenblatt’s quantitative strategy on 26/11/2021.
During the last year I’ve scooped up 4 batches of 7 stocks leaving me with a portfolio of 28 stocks as of the time of writing.
Here’s how the portfolio shaped up prior to the new purchases I’ll discuss today:
QuantCompounder Portfolio 20/11/2022: Individual Holdings
Source: Sharesight
QuantCompounder Portfolio 20/11/2022: Sector Classification
Source: Sharesight
Interesting to see Health Tech and Health Services making up about 25% between them when breaking grouping the portfolio by sector. Something I’ve seen highlighted by other Magic Formula enthusiasts with possible explanations including unusually high ROICs for healthcare providers as a result of new drug releases during the pandemic.
Buy or Hold?
With 4 batches and 28 Magic Formula stocks later, the moment finally came to hold or sell existing holdings from Batch 1.
“Sometimes a previously owned stock will remain on the list and then you must decide if you want to continue to hold this stock”. Joel Greenblatt
I decided that if, after my 3-step filtering process, an existing holding still remains on the list, I will neither sell nor rebalance the stock to make it 1/28 of the portfolio.
Instead, I’ve decided to just leave it and simply allocate 1/28 of the total invested capital into any new purchases. Peter Lynch said it's that selling your best stocks and buying your worst performing ones is like "pulling out the flowers and watering the weeds.” I don’t intend to pull out any flowers.
I like this approach because it introduces the concept of letting your winners run and the ‘forever’ holding period popularised by Warren Buffett. Perhaps we can popularise ‘quanting’ the ideas and ‘compounding’ the winners with this publication?
Selection criteria
I continue to refine my strategy. Here are 2 new rules I’ve added before applying my 3-step filtering process for selecting stocks:
Stocks must have positive a 10-Yr Median ROIC
Stocks that weren’t due to be sold in the current batch must be removed
The first new rule is simply a way to weed out the stock that I’ll never own. It also increases the probability of more stocks with a higher 10-Yr Median ROIC above 10% which is my target so should increase the overall quality of companies in the initial screen.
The second rule ensures stocks that haven’t yet reached the 1-Yr mark are removed from the screen entirely, to give them a chance to reach the 1-Yr mark without getting replaced unfairly.
I decided to introduce this rule after existing holdings like ASO, HPQ, ITOS and INVA appeared on the latest screen. I didn’t replace ASO and HPQ since they had both reached the 1-Yr mark and were therefore eligible for substitution. I removed ITOS and INVA since they hadn’t reached a 1-Yr holding period in the portfolio yet.
New adds
I updated the 3-step filtering process (again!) this round to the below:
10-Yr Median ROIC must be above 10%
EV/EBIT must be below 10
FCF Margin must be positive
I decided to use EV/EBIT as my second filter rather than Net Debt/FCF since I believe it gives investors a better overall picture of a given company’s value (including outstanding debt and available cash) in relation to its profits.
The lower the multiple, the better for an investor. The company with small amounts of debt and/or large cash holdings will have a smaller EV than the company without, which would produce a lower EV/EBIT multiple provided profits stayed the same or expanded at an equal clip.
This resulted in the below selections:
Source: QuantCompounder Research
Interesting to see Thor Industries make the list, one I’ve followed for a while being a competitor of a holding in my personal portfolio. HP Inc managed to earn its place in the portfolio for another year ranking 5/7 behind OGN, HCC, SIGA and RHI.
Let’s now turn to the 1-Yr Compounded Annual Performance of my modified Magic Formula portfolio.
Performance
I am tracking performance on Sharesight where total return in split into capital gains, dividends and currency gains.
Source: Sharesight
As of the time of writing 28/11/2022 UTC+01:00 the portfolio is down -12.96% from share price movements since inception (26/11/2021) vs. -15.87% for the S&P500.
The portfolio gained 0.62% from dividends vs. S&P500 during the same time period.
The Magic Formula portfolio increased 2.07% from currency fluctuations vs. a 7.45% gain for the index during the same time frame.
This gives a total return of -10.27% for the Magic Formula portfolio in Yr 1 vs. -7.01% for the S&P500.
Am I disappointed?
No. If we exclude the gains from currency fluctuations we’re actually up against the S&P500 for the year by 2.12% (-12.34% Magic Formula vs. -14.46% S&P500). I am quite happy with these results considering the crazy year we’ve experienced in the markets. If the portfolio can continue to outpace the S&P500 by over 2 percentage points over a prolonged period that could translate into significant value.
I’ve also gradually refined my selection process to one with which I am happy. No doubt I will continue to optimise and iterate but I believe things are moving in the right direction and I am ever-excited to see if the portfolio will outpace the index over the long term.
Would love to hear your thoughts and comments.
Let me know if there’s anything you’d have done differently!
QC
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