What are we looking for?
Yesterday, we checked in with our Canadian “magic formula” stocks and discovered that the portfolio is badly trailing the market, dragged down by large losses in companies such as Research In Motion and Yellow Media.
Today, we’ll get an update on our U.S. magic formula portfolio, created in April.
U.S. money manager Joel Greenblatt detailed his stock-picking strategy in The Little Book that Beats the Market, published in 2006. His formula aims to find companies that are both profitable and cheap by focusing on two measures: return on capital and earnings yield.
The higher the return on capital – which he defines as pretax operating profit divided by the sum of net working capital and net fixed assets – the more effectively a company is using its capital to generate profit.
The higher the earnings yield – defined as pretax operating profit divided by enterprise value, or the sum of stock and debt – the more attractive the stock is from a valuation standpoint.
We used the stock screener at magicformulainvesting.com to select U.S. companies with a minimum market capitalization of about $2-billion (U.S.). We invested a hypothetical $50,000 in each stock, for a total of $1-million.
Since the portfolio was created on April 26, it’s down 6.4 per cent in U.S. dollars through June 21. That compares with a drop of 3.8 per cent over the same period for the S&P 500.
A couple of months isn’t long enough to judge the success of an investment strategy. We’ll check back from time to time and update you on the portfolio’s performance. Remember to do your own due diligence before investing in any security. Use screens such as magicformulainvesting.com as the starting point for further research, not as the last word on what stocks to buy.