Author Topic: The Little Book That Beats The Market  (Read 13824 times)

Yabev15

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The Little Book That Beats The Market
« on: January 08, 2015, 01:05:29 PM »
Last year I read Joel Greenblatt's The Little Book That Beats The Market....

I decided to invest $2,500.00 every three months choosing stocks on the website and I'm coming up on my first sale/purchase re-allocation on January 15th, 2015.

The reason why i'm writing this post is because I've recently started to doubt the strategy and I am wondering if I should sell all of my holdings and open a Vanguard account now that I have 10k to invest in their low cost index fund.

The question I have is have others had success using Joel's formula and think I should stick it out like the book suggests (3 to 5 years minimum) or would people recommend I sell and purchase a low cost index fund from Vanguard.

Also, I currently max out my employer tax free 401k account so investing above is additional saving for early retirement.



RapmasterD

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Re: The Little Book That Beats The Market
« Reply #1 on: January 08, 2015, 01:39:30 PM »
Joel Greenblatt consistently beats the market with his book franchise. It HAS to be a key source of revenue for him.

You wanna buy 30 stocks and deal with all that complexity and record keeping?

Have at it.

NEXT!

P.S. I recommend you move on. But don't take my word for it. Read the Amazon reviews and look at the common themes.

surfhb

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Re: The Little Book That Beats The Market
« Reply #2 on: January 08, 2015, 02:01:10 PM »
I guaran-fuckin-tee you Joel Rosenblatt is taking the money you give him and putting it in index funds!   Ha Ha!

hodedofome

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Re: The Little Book That Beats The Market
« Reply #3 on: January 08, 2015, 02:39:07 PM »
Since the end of 2004, when the book was first published, the Magic Formula as described in the book has returned 12.68%/yr (CAGR) while the Vanguard US Total Stock Market Index has done 8.1%/yr. Although that may not be near the outperformance as originally described in the book, it has still theoretically beaten the market.

I took the data from the Little Book that Still Beats the Market that updates the test from 2004 to 2010, and I've been live tracking the strategy in a spreadsheet each year since then. Although these are not results from a real money portfolio, you can do with it whatever you want.

That being said, if you aren't 100% certain that it's the strategy for you, then of course you should not follow it. You will not stick with a strategy if you don't believe in it. This is why Joel Greenblatt (who I personally believe he's genuinely trying to help the little guy, he doesn't need our money, trust me) started his mutual funds, because the people who tried to follow the strategy on their own inevitably underperformed on a consistent basis. It was their own emotions and psychology that kept them from following a black and white rules-based strat. He found that people made much more money by letting Greenblatt make the trades, even though theoretically they should have performed the same.

So, IMO, the problem is not necessarily the strategy. The problem is you. You should find something that fits your personality and that you'll stick with it no matter what.

Yabev15

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Re: The Little Book That Beats The Market
« Reply #4 on: January 08, 2015, 08:04:45 PM »
Thank you hodedofome, I really appreciate the feedback. I will have to sit down and really think about Joelís strategy and if itís whatís best for me. 

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #5 on: January 08, 2015, 08:25:32 PM »
Thank you hodedofome, I really appreciate the feedback. I will have to sit down and really think about Joelís strategy and if itís whatís best for me.

Joel Greenblatt has talked about this behavioral problem himself many, many times in articles, interviews, and other communications over the year. The main problem with the Magic Formula is that people just can't seem to stick with it.

Just as most people can't seem to stick with investing or volatility in general.

By the way, I practice the Magic Formula strictly, mechanically, and by-the-book, as a portion of my overall portfolio.

Also, expect comments like many of those above whenever you talk about the Magic Formula on any forum. People who haven't actually read Greenblatt's writings love to chime in with "clever" quips. That's actually one of the reasons the Magic Formula continues to work. It'll never truly be in favor.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #6 on: January 08, 2015, 10:42:53 PM »
Ironically, I think it would work best for someone who already has their investing shit in order and was was looking to increase returns a little.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #7 on: January 08, 2015, 11:07:27 PM »
Ironically, I think it would work best for someone who already has their investing shit in order and was was looking to increase returns a little.

Definitely. What the Magic Formula is, is a way to build your own index fund consisting of stocks that are cheaper (by EBIT/EV) than the market and better (higher adjusted ROIC) than the market. It takes more discipline, because you need to avoid the temptation to cherry-pick and also the temptation to market-time with when you make your picks. Those risks exist in index investing too, of course, but are not as apparent.

To practice it well, you need to understand both why it works, why it often underperforms, and also most importantly the behavioral risks.

I'm actually writing an article right now on these operational aspects of the Magic Formula. Will link it here when it gets published.

hodedofome

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Re: The Little Book That Beats The Market
« Reply #8 on: January 09, 2015, 12:56:09 PM »
I expect to use the Magic Formula, exactly as portrayed in the book, as a small portion of my portfolio one day in the future. I don't need it now, but when income taxes are big enough, I'll be using it for sure.

Although it is pretty popular from the book sales and online chatter, I don't see too many people actually using it. Big funds won't touch stocks under a billion, nor can they be that concentrated, and regular investors are too emotional and ignorant to follow it for long. That leaves individual investors who know what they are doing as about the only competition out there for me.

But individual investors who know what they are doing are probably too prideful or 'smart' to just follow a system and leave it at that. They'd want to dig into each company and find out whether it's really a good investment or not. So they'd tinker until they weren't really following it anymore. Maybe they'd turn out better, maybe not. But the key is that I wouldn't have too much company so the trader effect shouldn't be as big of an issue as some believe.

As for the system itself, I like the simplicity and elegance of it. It's not overly optimized to past data and after reading Ben Graham's later writings, it seems he was working on his own magic formula as well. I think he realized in his old age that you could use a simple but well thought out system to pick a diversified group of stocks that would perform every bit as well as an individual stock picker.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #9 on: January 09, 2015, 11:14:52 PM »
I expect to use the Magic Formula, exactly as portrayed in the book, as a small portion of my portfolio one day in the future. I don't need it now, but when income taxes are big enough, I'll be using it for sure.

Although it is pretty popular from the book sales and online chatter, I don't see too many people actually using it. Big funds won't touch stocks under a billion, nor can they be that concentrated, and regular investors are too emotional and ignorant to follow it for long. That leaves individual investors who know what they are doing as about the only competition out there for me.

But individual investors who know what they are doing are probably too prideful or 'smart' to just follow a system and leave it at that. They'd want to dig into each company and find out whether it's really a good investment or not. So they'd tinker until they weren't really following it anymore. Maybe they'd turn out better, maybe not. But the key is that I wouldn't have too much company so the trader effect shouldn't be as big of an issue as some believe.

As for the system itself, I like the simplicity and elegance of it. It's not overly optimized to past data and after reading Ben Graham's later writings, it seems he was working on his own magic formula as well. I think he realized in his old age that you could use a simple but well thought out system to pick a diversified group of stocks that would perform every bit as well as an individual stock picker.

I mechanically use the Magic Formula for a portion of my portfolio. The key is avoiding behavorial bias. Greenblatt has talked about this before in interviews and articles, and Tobias Carlisle and Wesley Gray further expounded on this problem in their fantastic book Quantitative Value as well. It's really, really hard to stick with the system.

solon

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Re: The Little Book That Beats The Market
« Reply #10 on: January 10, 2015, 02:48:23 AM »
Has anyone been able to replicate the list of stocks on www.magicformulainvesting.com in another stock screener? Care to share your screens?

hodedofome

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Re: The Little Book That Beats The Market
« Reply #11 on: January 10, 2015, 06:25:37 AM »
Solon I've tried. There's other online screeners out there but they never have exactly the same stocks. Differences in data sources can make a big difference, and I suspect Greenblatt uses a pretty high quality (expensive) source. The few screeners that actually use EBIT/EV and ROIC probably use free sources of data whereas Greenblatt is using Compustat or something like that. I also suspect they manually comb through the list as well since it still helps to look at the numbers with a human to make sure they are correct/make sense.

solon

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Re: The Little Book That Beats The Market
« Reply #12 on: January 10, 2015, 06:49:23 AM »
That's the impression I got, too. I just wish there was more than one way to pick these stocks. It's probably not good to be too dependent on one site.

hodedofome

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Re: The Little Book That Beats The Market
« Reply #13 on: January 10, 2015, 05:34:44 PM »
Well, you can use your own data and screen them yourself. You Kay not come up with the exact list but if your methodology is sound, on the average you should come out about the same.

You can also buy QVAL, which is kissing cousins to the magic formula. Its one of the few funds out there that's concentrated enough to actually do something.

Ynari

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Re: The Little Book That Beats The Market
« Reply #14 on: January 10, 2015, 07:50:55 PM »
I find this post relevant for all these "beating the market" threads and ideas: http://www.joshuakennon.com/what-do-you-think-of-rods-investment-system/

The moral of the story is that if you pick a strategy that optimizes your taxes/expenses, isn't based on timing or speculation, and STICK TO IT, you're going to do pretty good.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #15 on: January 10, 2015, 08:29:13 PM »
I'm currently running Magic Formula on the Australian stock market. It's quite manual until I work out a better way but in case you're interested I'm trying to use data from YQL. Will let you know how it goes.

* * * * *

The things I don't like about Magic Formula:

It's pretty hands-on, even though what you have to do is formulaic.
There are a lot of trades, which cost money.
It's not tailored for the Australian market in terms of tax treatment, not backtested, etc.

Since freznow mentioned Kennon, I had thought of using his articles here in order to put together something similar:

http://beginnersinvest.about.com/od/Business-Valuation/a/How-To-Tell-When-A-Stock-Is-Overvalued.htm
http://beginnersinvest.about.com/od/research/fl/6-Signs-You-May-Have-Found-a-Cheap-Stock.htm

Then just once a year re-run the formula on new data and make the changes in one hit.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #16 on: January 10, 2015, 10:23:43 PM »
Hm ok doing it on the Australian stock market gives you a large number of pharmaceutical/biotech companies and software companies. I could probably get about 8-10 stocks.

Also if you limit it to ROA > 25% companies then it whittles the list down to about four companies lol

KMB

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Re: The Little Book That Beats The Market
« Reply #17 on: January 11, 2015, 09:56:18 AM »
I attempted to implement this strategy and failed pretty quickly due to bad execution on my part, so I bought Greenblatt's Magic Formula mutual fund. Unbelievable performance, 44% first year return or something along those lines. Then, for reasons I don't understand, he closed the fund and rolled remaining accounts into this fund: http://quotes.morningstar.com/fund/genix/f?t=genix. It has an enormous minimum investment. I have no where near that much invested with him, but they allowed the existing mutual fund investors to roll over whatever their account balances were into the new fund.


Also, expect comments like many of those above whenever you talk about the Magic Formula on any forum. People who haven't actually read Greenblatt's writings love to chime in with "clever" quips. That's actually one of the reasons the Magic Formula continues to work. It'll never truly be in favor.

Do you think he names his books like this on purpose? So Bogleheads scoff and ignore him? That would actually be kind of brilliant.

Obviously we've found some Greenblatt fans in this thread; has anyone else read his fantastic but even more unfortunately titled You Can Be a Stock Market Genius? This book was completely mind blowing. I'm planning on attempting to do this myself in retirement; it would be way too time consuming to try before then.

hodedofome

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Re: The Little Book That Beats The Market
« Reply #18 on: January 11, 2015, 10:24:00 AM »
Yeah Greenblatt has some of the most ridiculous book names you can find...but are actually worth reading. Another one is How I Made $2 Million in the Stock Market by Nicholas Darvas. Sounds shady, but is good.

I think it's book publishers that force them to choose these titles.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #19 on: January 11, 2015, 06:46:29 PM »
You Can Be a Stock Market Genius is the book that launched a thousand hedge fund careers. David Einhorn followed those techniques in his first few years. The best practitioner of them today is H. Kevin Byun of Denali Investors. The problem is that spinoffs and corporate actions only scale so much. Up until you have,  say, $10 billion (lol). So they've always been great strategies for individual investors who actually do the work (almost none of them).

On the other hand, this area of the market has indeed gotten more crowded since Greenblatt wrote the book. I think the secret isn't doing exactly what he said to do but instead taking the philosophy of looking for structurally obscure bargains into mind.

Scandium

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Re: The Little Book That Beats The Market
« Reply #20 on: January 12, 2015, 07:32:26 AM »
I attempted to implement this strategy and failed pretty quickly due to bad execution on my part, so I bought Greenblatt's Magic Formula mutual fund. Unbelievable performance, 44% first year return or something along those lines. Then, for reasons I don't understand, he closed the fund and rolled remaining accounts into this fund: http://quotes.morningstar.com/fund/genix/f?t=genix. It has an enormous minimum investment. I have no where near that much invested with him, but they allowed the existing mutual fund investors to roll over whatever their account balances were into the new fund.


An expense ratio of 2.25% and 365% turnover? Sign me up!

hodedofome

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Re: The Little Book That Beats The Market
« Reply #21 on: January 12, 2015, 10:32:28 AM »
An expense ratio of 2.25% and 365% turnover? Sign me up!

A steal compared to the 2 & 20 that most hedge funds charge for the same thing. FWIW GENIX has done great since inception. Fees or not, outperformance is outperformance.

There's QVAL for the rest of us now. .79% fees and tax efficiency is one of the primary goals of the ETF. It may not have any taxable turnover at all, just dividends and capital gains upon selling.
« Last Edit: January 12, 2015, 10:37:40 AM by hodedofome »

RapmasterD

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Re: The Little Book That Beats The Market
« Reply #22 on: January 12, 2015, 02:45:40 PM »
I find this post relevant for all these "beating the market" threads and ideas: http://www.joshuakennon.com/what-do-you-think-of-rods-investment-system/

The moral of the story is that if you pick a strategy that optimizes your taxes/expenses, isn't based on timing or speculation, and STICK TO IT, you're going to do pretty good.

Freznow -- Awesome link. Great read. Thank you for sharing.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #23 on: January 12, 2015, 07:19:32 PM »
My article on the Magic Formula is going up on Seeking Alpha soon. This discussion was very helpful for clarifying my thinking about some of the concerns regarding the Magic Formula.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #24 on: January 13, 2015, 01:56:57 AM »
If any of you have access to Bloomberg terminal the EQS function has a "Greenblatt Inspired Screen" under "Gurus." There are a few differences from Greenblatt's Magic Formula (eg min market cap at 1bio) but there is no faulting the underlying data.

Made some modifications and ran it on Australian data. Again, I'm looking at a page full of beat-up miners/energy stocks, biotechs, as well as companies that have been in the news for all the wrong reasons lately. You'd need nerves of steel to pull this off.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #25 on: January 13, 2015, 02:26:26 AM »
If any of you have access to Bloomberg terminal the EQS function has a "Greenblatt Inspired Screen" under "Gurus." There are a few differences from Greenblatt's Magic Formula (eg min market cap at 1bio) but there is no faulting the underlying data.

Made some modifications and ran it on Australian data. Again, I'm looking at a page full of beat-up miners/energy stocks, biotechs, as well as companies that have been in the news for all the wrong reasons lately. You'd need nerves of steel to pull this off.

Alas, I am a mere peasant without a Bloomberg terminal (and don't think I ever will have one, except at a future job, perhaps). The yearly subscription alone would cover my living needs!

It's interesting that you have miners and energy stocks in the Australian Magic Formula. One of the strengths of the Magic Formula last year was that it pretty much avoided energy stocks, as their ROIC is generally quite low. Perhaps the Australian stock market isn't deep or large enough for the Magic Formula to work. Personally, I would avoid it. Part of the strength of using the Magic Formula is that you know that it works in a very robust way, given accurate back-tested data, and why it works. I don't know much about the Australian stock market, but I would imagine that the characteristics of it cannot be identical to the US stock market. It's surely more of a derivative of China, for example. So you wouldn't have the confidence to apply it mechanically, which is what you need to do to have it actually work. Tweaking the formula leads to disastrous results, as my Seeking Alpha article will cover.

You do need nerves of steel. That's why it's so hard for anyone to actually stick with it, even if it sounds easy in practice. And that's why it'll continue to work. For example, among other stocks, my US Magic Formula portfolio has Gamestop (GME), Herbalife (HLF) and King Digital (KING). I exercised no discretion why I bought them. They could all go to zero before I sell. But I'm confident that the strategy will, over a long enough time horizon, and across a sufficient number of stocks, work out.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #26 on: January 13, 2015, 03:32:14 AM »
Last year was the end of a bull run for Aussie miners, so their ROA is still quite high. This time next year would be a different story I'd say, and if I was going to do it now I could cut the miners just as easily.

Dick Smith Electronics was near the top (think: Radioshack), as were two network TV companies.

If I was going to do it, I'd take the next $5000 that was destined for the usual Australian index tracker and instead spread it across six or seven of these sorry companies, trying to get a mix of sectors and market capitalisations.

That's the other thing: I'm not prepared to experiment with more than about $5K on every 100K in my main strategy.

Do you have any suggestions for some good analysis of this strategy? Besides the book itself.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #27 on: January 13, 2015, 03:38:36 AM »
Oh, the other thing to note is that this strategy is only as maintainable as I have access to Australian data. If I lose my BBG license I'm floating down the river without a paddle.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #28 on: January 13, 2015, 08:15:04 AM »
Last year was the end of a bull run for Aussie miners, so their ROA is still quite high. This time next year would be a different story I'd say, and if I was going to do it now I could cut the miners just as easily.

Dick Smith Electronics was near the top (think: Radioshack), as were two network TV companies.

If I was going to do it, I'd take the next $5000 that was destined for the usual Australian index tracker and instead spread it across six or seven of these sorry companies, trying to get a mix of sectors and market capitalisations.

That's the other thing: I'm not prepared to experiment with more than about $5K on every 100K in my main strategy.

Do you have any suggestions for some good analysis of this strategy? Besides the book itself.

I'd recommend all of Greenblatt's articles and interviews that you can find on the internet (there are quite a few), as well as Quantitative Value by Carlisle and Gray.

My Seeking Alpha article on the subject was just published, as well. I guess I'm not allowed to post the link here...(I posted the link to the article on my blog in my signature).

hodedofome

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Re: The Little Book That Beats The Market
« Reply #29 on: January 13, 2015, 10:59:49 AM »
What is your process for dealing with a stock that gets bought out in the middle of the year? Will you hold the buying company's stock until the re-balance date? Will you add another stock from the list? How do you determine which stock to add? Randomly?

My current idea for a workaround is just to replace the stock with SPY and then rebalance the whole portfolio at the same time as usual. I don't feel comfortable with my stock picking ability to intelligently pick from the list, I'd rather avoid random picking, and unfortunately the list on the magic formula website is not sorted by rank, just alphabetically by name.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #30 on: January 13, 2015, 04:13:02 PM »
Why are you unable to place a link?

I read your article btw. Seems like I do have to just trust the process. I guess the "good" news is that I don't have the money to go in just yet - transaction costs would finish me off. But I've made an entry in my Google Calendar a year from now with the stocks that are currently out of favour with Mr Market and their prices so I can see just how much I'd have made/lost in one iteration.

Also need to confirm how tax works for Australians and holding less than/more than one year.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #31 on: January 13, 2015, 08:42:42 PM »
What is your process for dealing with a stock that gets bought out in the middle of the year? Will you hold the buying company's stock until the re-balance date? Will you add another stock from the list? How do you determine which stock to add? Randomly?

My current idea for a workaround is just to replace the stock with SPY and then rebalance the whole portfolio at the same time as usual. I don't feel comfortable with my stock picking ability to intelligently pick from the list, I'd rather avoid random picking, and unfortunately the list on the magic formula website is not sorted by rank, just alphabetically by name.

That actually happened with Questcor. I dealt with it by simply selling after I got issued the new shares. My theory behind this is I owned a different company that had not been screened for. This is tricky, and I hate that there's this discretion. I guess if you are just consistent with either holding or selling, it'd be ok.

I didn't replace it with another stock on the list. I also don't reinvest dividends. So I basically treated it as a big capital return/dividend. But if I reinvested dividends, I would replace the stock with another random one I didn't own from the list.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #32 on: January 13, 2015, 08:44:39 PM »
Why are you unable to place a link?

I read your article btw. Seems like I do have to just trust the process. I guess the "good" news is that I don't have the money to go in just yet - transaction costs would finish me off. But I've made an entry in my Google Calendar a year from now with the stocks that are currently out of favour with Mr Market and their prices so I can see just how much I'd have made/lost in one iteration.

Also need to confirm how tax works for Australians and holding less than/more than one year.

I saw the Miles Dividend MD repeatedly got links to his blog deleted, so I guess I just want to stay on the safe side...

I think that's a good way to go. You have to make sure you're comfortable. But also keep in mind that one year isn't indicative of the strategy's overall performance. The Magic Formula has historically had some very bad years of underperformance, as Greenblatt repeatedly emphasized in The Little Book That Still Beats the Market.

hodedofome

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Re: The Little Book That Beats The Market
« Reply #33 on: January 13, 2015, 08:53:02 PM »
Any single method is going to have a string of years of underperformance. That's why some guys combine styles or strategies that are uncorrelated so that hopefully the returns and valleys are smoothed out.

For me it took spending thousands of hours researching strategies and back testing until I felt the confidence I needed to stick with the strategy through thick and thin. When something has been used for 100 years, you have a pretty good idea it will continue to work. Especially if it relies on the failure of human nature. Value and momentum fit this bill, so that's what I focus on currently.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #34 on: January 13, 2015, 10:09:53 PM »
I am comfortable mechanically applying the mechanical Magic Formula because I intuitively understand why it should work. If you own companies in the market that are on the whole quantitatively cheaper than average and better than average, you will do better than the market, because stock ownership is business ownership, and you are getting better businesses at cheaper prices. It's axiomatic. That's coincidentally why I don't have money in QVAL - I really don't like that they complicated things with forensic accounting screens and the like. I understand why they did it (and I think Alpha Architect does believe in their process, it's not solely a way to justify the management fee, although it is that too). But I prefer to keep things simple.

If 1/3 of the market was net-nets as it was in Benjamin Graham's day, I would be happy having my entire portfolio in net-nets. That makes sense to me as well - buy companies for below their liquidation value. But that's no longer an investable strategy. The Magic Formula ranks companies relative to each other, so it will always be investable. (It also of course means that you will end up buying overvalued stocks if the market gets 100% crazy - it won't safely keep you in cash like other strategies sometimes will.) I like that.

dungoofed

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Re: The Little Book That Beats The Market
« Reply #35 on: January 14, 2015, 02:21:21 AM »
Any single method is going to have a string of years of underperformance. That's why some guys combine styles or strategies that are uncorrelated so that hopefully the returns and valleys are smoothed out.

Seems like Magic Formula is completely unconcerned with (positive nor negative) growth, so you get a lot of companies in industries that are next in line for disruption (eg two network TV companies in Australia's case). I can't remember where I saw it now (may have been the book) but I seem to recall that growth is taken into account by virtue of the fact that people are working hard towards the goal of making their company better.


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Value and momentum fit this bill, so that's what I focus on currently.

Do you have any gurus you can recommend for the momentum part?

hodedofome

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Re: The Little Book That Beats The Market
« Reply #36 on: January 14, 2015, 11:07:50 AM »
Innerscorecard mentioned Alpha Architect and there's a good bit of info on momentum at their site. Others that have written quite a bit on it would be Meb Faber and Gary Antonnacci. Dorsey Wright's blog also.

innerscorecard

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Re: The Little Book That Beats The Market
« Reply #37 on: January 14, 2015, 08:02:44 PM »
For momentum, I would of course also read what Asness and AQR have put out, although I find Asness not the most readable writer.