Archive for category Magic Formula

Graham’s Last Will Screen–List of Stocks

Benjamin Graham is probably one of the foremost gurus in Value Investing. His tenets have been proved true over and over, for the past 75 years. His ‘Intelligent Investor’ (II) is a must read for any investor. The more financially inclined can also peruse ‘Security Analysis’ (SA) although it is way more involved than the former one.

Anyway, in this blog post, I am listing out stocks which have passed the Graham’s Last Will statement. What does the ‘Last Will’ mean? Well, the story goes that when Graham initially wrote II&SA, he came up with 10 criteria to find undervalued stocks, which over long term would comfortably beat the market. However, as the years passed by, Graham shortened the 10 criteria and just before his death (and hence Last Will), he came up with 4 criteria which he claimed would comfortably beat the market.

I have come up with the list of stocks using the wonderful ValuePickr screener.

Graham’s 10 criteria for picking up undervalued stocks (written way back in the 1930s and still serve as an extremely good guidance to pick up stocks) were –

1. An earnings-to-price yield at least twice the AAA bond rate

2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years

3. Dividend yield of at least 2/3 the AAA bond yield

4. Stock price below 2/3 of tangible book value per share

5. Stock price below 2/3 of Net Current Asset Value (NCAV)

6. Total debt less than book value

7. Current ratio greater than 2

8. Total debt less than 2 times Net Current Asset Value (NCAV)

9. Earnings growth of prior 10 years at least at a 7% annual compound rate

10. Stability of growth of earnings in that no more than 2 declines of 5% or more in year end earnings in the prior 10 years are permissible.

Needless to say, when I ran these criteria over today’s list of Indian stocks, the number of stocks dwindled down to 0 by Criteria No. 5.

(I took the recent SBI Bond rate as the AAA bond rate. SBI bonds were being offered at 9.25% for a 10 year bond (I approximated the AAA bond rate to be 9% for easier calculations))

However, Graham in his Last Will (it’s actually called Last Will and Testament) suggested 4 simple criteria which would stand the test of time and comfortably beat the market (and thanks to Jae Jun’s incredible back testing skills on the American Stock Market (you can check out the performance using these 4 criteria on US markets; I would wager that similar performance can be observed in the Indian markets too!) – btw, Jae Jun is fantastic. You have to follow his blog). The four criteria were –

1. An earnings-to-price yield at least twice the AAA bond rate

3. Dividend yield of at least 2/3 the AAA bond yield

6. Total debt less than book value

7. Current ratio greater than 2

Well, I took these 4 criteria  and ran it on ValuePickr screener (and I did try to back test on ValuePickr, but couldn’t – I wasn’t able to get values for previous years on the screener) and these were the results –

Company Current Ratio D/E Div Yield% Earnings Yield % Industry
Alufluoride 3.22 0 8.82 25.21 Inorganic Chemicals
Amrutanjan Health Care 7.95 0 8.3 42.78 Pharma
Anuh Pharma 2.39 0.01 6.85 18.68 Pharma
Bhagiradha Chemicals & Industries 2.52 0.48 7.06 44.33 Pesticides & Agro Chemicals
Ecoboard Industries 3.6 0.41 11.35 19.36 Other Machinery
Flex Foods 3.27 0.41 6.42 21.62 Food & Beverages
Helios & Matheson Information Technology 8.92 0.57 6.5 33.8 Computer Software
Indage Vintners 4.34 0.71 9.76 121.36 Food & Beverages
K C P 2.57 0.72 33.17 154.44 Construction Materials
Nissan Copper 3.85 0.95 16.3 102.62 Non Ferrous Metals
Oriental Hotels 2.48 0.67 23.37 40.38 Hotels & Resteurants
Panoramic Universal 27.4 0.88 12.17 71.49 Computer Software
Rajkumar Forge 6.93 0.45 6.39 19.57 Castings & Forgings
Zenith Birla (India) 2.04 0.65 39.6 21.56 Steel

The deal with the results is that these stocks need to be moved out of the portfolio every year and re-invested in stocks which fulfill these criteria the following year (much like Magic Formula investing)

(Total debt less than Book Value gives the exact same results as D/E < 1 (obvious) – so, you can run this screen either way on other screeners)

Any thoughts on the stock above? Should we (or can we) refine this further? Any way to back test these criteria? Inputs appreciated.


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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!]:

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): [GST, IFRS, DTC] [GST, IFRS, DTC] [IFRS, US GAAP and Indian GAAP]$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


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


5) Aswath Damodaran’s Valuation Spreadsheets:

This entire web site makes for fascinating reading.

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Summary of Investment Criteria

So, what do all those posts mean? Give me the meat. Give me the funda. Summarize.

Ok, here we go. This is an initial list we’ll work with and fine tune it and update it as we go along (Frankly, haven’t had the time to read up on and understand the significance of Price/Sales ratio, PEG ratio, Current ratio, Interest cover, Dividend yield and what’s a good EPS growth number, Insiders holding (according to Walter Schloss, it must be greater than 50%). Will learn about these and update this criteria as we move along in life).

Basically, Fundamentally and all -lly-s, here’s the real deal (click to enlarge) –

Now that we have covered some basics of value investing, we shall proceed to screening stocks based on some of these criteria and see how the results turn up. I hope to have something by tomorrow. Happy Investing!

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Diversified Portfolio

After reading a ton of information across various websites, I will settle on the following rules for the diversified portfolio (~15-25 stocks) –

1. Asset allocation: 25% Debt/Cash – 75% Stocks

2. Diversify and buy value stocks

3. Sell a bit (1/5th) if stock increases by 25%.

4. Sell completely if stock increases by another 25%.

5. More than 50% profits – sell after one year and reinvest in another MFI stock

6. Buy more if stock falls by 20%/More than 20% loss – sell before one year (depending on the stock)

I will consider a stock that has value if it passes the conditions of Magic formula and Graham principles –

1. Low P/E (High Earnings yield) and High ROIC (assign ranking according to Magic Formula and sort for different market capitalizations (Top 25 results in 50cr, 100 cr, 250 cr, 500 cr, 1000 cr, 5000 cr))

2. Stock’s P/B < 2/3

3. Debt/Equity < 1

4. No losses sustained in the last five years.

Among the stocks that pass all these conditions, I choose the best stocks depending on –

High ROE, Good management, Not a fad/cyclical stock, No banks, fin service companies etc., Not a declining industry/bleak future prospects, No wild fluctuations in EPS for the past 5 years, preferably different sectors, and will disregard if PE < 3 (this is getting more into a comprehensive valuation category, but a high level screening of the stocks selected would be enough for a diversified portfolio).

From Chandrakant Sampath and Shankar, I will blindly buy stocks which are at a 36 month low (if I get too bored, I mean really really bored, then I will buy stocks which are at a 24 month low). Here, I exploit the principle of reversion to mean espoused by Prof Sanjay Bakshi too, but I will reserve that discussion for later.

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Fundamental Ratios

There are some ratios which are specific to Magic Formula, which is a part of my initial hypothesis. These are:

Return on Capital (ROIC) = EBIT/(Net working Capital + Net Fixed Assets)

Earnings Yield (EY) = EBIT/Enterprise Value

EBIT: is calculated as the trailing twelve months operating profit if available

Net Working Capital: is calculated as Total Current Assets – Excess Cash – Total Current Liabilities if Total Current Assets exceeds Total Current Liabilities, otherwise it is zero

Net Fixed Assets: is calculated as Total Assets – Total Current Assets – Total Intangible assets

Enterprise Value: is calculated as Market Cap + Long-Term Debt + Minority Interest + Preferred Stock – Excess Cash. If the returned value for Enterprise value is negative, then a default value of 1 is used.

For a more comprehensive overview on different financial ratios, please refer these important links –


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