Author Topic: magic formula investing question  (Read 1767 times)

tkc

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magic formula investing question
« on: June 14, 2016, 01:38:52 PM »
after reading the Little Blue Book, I got all excited and started building portfolio using the magic formula. However, there is 1 question that is bothering me. Lets say I buy a stock X this year. According to the book I should sell it exactly after 1 year (+-1 day depending on loss or gain). But what if it still meets the magic formula criterion.
1. Do I not sell it? Or
2. Do I sell it and buy again? (makes no sense to me) or
3. Do I just buy more of it?

yoda34

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Re: magic formula investing question
« Reply #1 on: June 14, 2016, 04:02:46 PM »
Hi tkc,

The Little Book is a great book - one of my favorites. Greenblatt explains value investing in a way that is more understandable and straightforward than a lot of authors I've read. Having said that - you have to be really careful with MFI investing:

1. Greenblatt made an error calculating returns. No one (and I mean no one) has been able to recreate his back tests and get any where near the same out performance he claims in the book
2. Most backtests do show a slight outperformance vs. the S&P500 but it comes at a much higher volatility and overall drawdown
3. There are decades over which MFI has done really really poorly - be careful you know your time horizons
4. Greenblatt made most of his money in Risk Arb, Spinoffs, and other special situations. His funds that follow the MFI haven't done so well historically

If you still want to forth after that, then if it's in your portfolio and it still meets the criteria then just hang on to it. No reason to incur unneeded expenses. If I remember correctly Greenblatt doesn't explicitly recommend any rebalancing other than selling at the end of the year if it no longer meets the criteria. Ben Graham proposed his own formula before he died of investing in stocks of under PE 10 and at least 2 or greater assets to debt ratios. As part of his proposal Graham said to hold on to stocks for 2 years or until it returned at least 50% so something to consider.

One more warning that you have to be careful with straight factor based value investing. Lots of pitfalls and lots of knifes everywhere.

Metric Mouse

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Re: magic formula investing question
« Reply #2 on: June 15, 2016, 01:03:24 AM »
Ben Graham proposed his own formula before he died of investing in stocks.....

Sorry, I just snorted. This is a great line.