Interesting Reads: Enhanced Magic Formula and Regulation Changes

1. Enhanced Magic Formula: I recently came across the forum The Equity Desk. Lots of interesting ideas out there, along with some smart analysis.

One such analysis was done by ‘SmartCat’, which is probably an extension to Magic Formula (promulgated by Joel Greenblatt). I ran this extension by my list of stocks and found that, more or less, the results are almost the same as the Magic Formula. Yet, I do think this particular analysis gives a ‘higher level of comfort’ in terms of parameters used rather than just two in the Magic Formula. I think it’d be a great research paper if someone could use this enhanced Magic Formula to say, the BSE small cap/mid cap universe, and compare its returns with just the original Magic Formula for the same universe over the past 15 years and conclude if the results are similar/one model is better than the other. ‘SmartCat’ can probably write a book then 🙂 [Smart investment by the way – write once, reap cashflows for atleast the next 5 years 🙂 ]

{Between, can anyone point out to me any kind of results/research if Magic Formula actually works for the Indian markets? I’d be grateful!]

The original forum post (lots of good thoughts in response to this forum post too, do read them!]:

http://theequitydesk.com/forum/forum_posts.asp?TID=2929&PN=1

An excerpt of the enhanced Magic Formula investing by SmartCat:

Basically, this is a quantitative analysis of a set of stocks, based purely on their fundamentals. I’m only using the TED XI as an example – this methodology can be used on any portfolio to determine the best and the worst.
All the 11 stocks will be analysed based on –

P/E Ratio
Return on Equity
Last 4 years CAGR Sales Growth
Last 4 Years CAGR Profit Growth
Market Cap
P/BV Ratio
Debt to Equity Ratio
Dividend Yield
Last 4 Years CAGR dividend per share growth
Dividend Payout Ratio

Basically, we will be looking at parameters typically used by both “growth” and “value” investors.

Ranking Methodology:

– All the 11 stocks are ranked based on each parameter – say P/E Ratio to begin with. A stock with the lowest P/E Ratio gets the highest 11 points, while a stock with the highest P/E Ratio gets the lowest 1 point.

– Similarly, for other parameters like RoE, marketcap etc, each stock is awarded between 1 points and 11 points depending on where it stands compared to eachother.

– The scores are added at the end, and the stocks are ranked from 1 to 11.

Might not make much sense now, but as we go along, you’ll know what I mean.

Flaw in the Methodology:

Looks into the past rather than the future to rank the stocks.

If your portfolio has 50 stocks, then your highest point would be 50 and lowest would be 1. Do analyse your portfolio and let me know.

2) Regulation Changes: With lots of regulations coming in, regulations changing, I thought it’d be a good time to read up on some of the rules/regulations which are changing (feel free to add any new links in the comments):

http://business.outlookindia.com/article.aspx?262384 [GST, IFRS, DTC]

http://www.dnaindia.com/money/report_ifrs-gst-dtc-india-inc-has-an-alphabet-soup-of-laws-coming_1416059 [GST, IFRS, DTC]

http://www.pwc.com/en_IN/in/assets/pdfs/india-publications-similarities-differences.pdf [IFRS, US GAAP and Indian GAAP]

http://www.ey.com/Publication/vwLUAssets/Comperative_statement_on_Indian_GAAP_and_IFRS/$FILE/Comparative%20statement%20on%20Indian%20GAAP%20and%20IFRS.pdf [[IFRS, US GAAP and Indian GAAP]

 

3) The list of ET Top 100 fastest growing companies 2010

http://www.etintelligence.com/etig/researchchannels/investorsspecial/fastest100Companies.jsp

 

4) Free Small Cap and Mid Cap Research links by BSE and NSE. Great starting points without worrying about the target price –

http://www.bseindia.com/sensex/research.aspx

http://www.nseindia.com/content/corporate/eq_research_reports.htm

 

5) Aswath Damodaran’s Valuation Spreadsheets:

http://pages.stern.nyu.edu/~adamodar/

This entire web site makes for fascinating reading.

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  1. #1 by Chirag on January 1, 2011 - 12:43 PM

    Sounds Interesting!
    Even I had tested that formula once was good needs decent efforts as well 🙂

  2. #2 by Kiran on January 3, 2011 - 12:01 PM

    @Chirag – Cool! So, it works 🙂

    Visited your website – very interesting reads. Do post often!

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