Magic Formula: The new 2020-2021

We wrote an article on Joel Greenblatt’s Magic formula in Indian Context where we backtested the strategy between FY02 and FY20. The strategy invests in the businesses with high RoCE and low earnings yield i.e. buying good companies (that have a high return on capital) and to buying those companies only at bargain prices (that have a high earnings yield).

This is a ‘buy and forget it for one year’ strategy that has to be rebalanced every June end when 25 companies are selected for the portfolio with equal allocation for the upcoming year. We are now ready for the 2020-2021 portfolio.

The strategy makes sense if you intend to follow it for at least a decade or longer. So we shouldn’t fixate too much on short term performance. But the strategy has done well in the past and has never underperformed any benchmarks over any 5-years between FY02-FY20.

We have created three portfolios based on this strategy: the traditional magic formula which we have called as the standard portfolio, one based on large-cap and mid-cap stocks which have called as the Top-250 portfolio and the last one where we have tried to eliminate cyclical businesses which we have called as the Minimum RoCE benchmark portfolio.

The Standard Portfolio:

For 2020 – 2021, our strategy has selected the following stocks for the standard portfolio:

The Top-250 Portfolio:

For 2020 – 2021, our strategy has selected the following stocks for the top-250 portfolio:

The Minimum RoCE benchmark portfolio:

For 2020 – 2021, our strategy has selected the following stocks for the minimum RoCE benchmark portfolio:

As the strategy focuses equally on the valuation of a stock along with the performance of the business, there can be a misconception that most of the stocks would be beaten down or near 52-week lows. But we surprisingly found out that the stocks in each portfolio are down 20-25% on a median basis from 52-week highs. You can track the portfolio performance on this sheet.

We have invested nearly 10-15% of our portfolio for this strategy on the 2nd of July to start with. We incline to invest in the portfolio with the RoCE benchmark which helps us eliminate cyclical stocks and reduce the draw-downs as can be seen in our backtesting. We are hopeful that magic is not only in the air and this strategy will succeed in the future as it has performed in the past.

Note, anyone who invests in any strategy needs to do their research/due diligence and are themselves fully responsible for the outcome.