Value Investing 1 - The Magic Formula

Step by Step Instructions

Step 1: go to magicformulainvesting.com

Step 2: follow the instructions for choosing company size (it works better with market capitalizations from 50m to 100m)

Step 3: follow the instructions to obtain a list of top-ranked magic formula companies

Step 4: buy 5-7 top-ranked companies with lower priced Web brokers or deep-discount brokers. To start, invest only 20%-33% of the money you intend to invest during the first year

Step 5: repeat step 4 every 2-3 months until you have invested all of the money you have chosen to allocate to your magic formula portfolio. After 9-10 months, this should result in a portforlio of 20-30 stocks.

Step 6: Sell each stock after holding it for one year. For taxable accounts, sell winners after holding  them a few days more than one year and sell losers after holding them a few days less than one year. Use the proceeds from any sale and any additional investment money to replace the sold companies with an equal number of new magic formula selections. (step 4)

Step 7: Continue  this process for many years. Remember, you must be committed to continuing this process for a minimum of 3-5 years to see it really works.

My Alternation to Magic Formula Instructions

• Use the list you get from magicformulainvesting.com as a starting point
• Use Global and mail stock screener to go through the list 
• Only pick up stocks with Return on Assets >=25% (ROA=Earnings/total assets) and Earning from operating > 0.5/share since its inceptions
  https://www.theglobeandmail.com/investing/markets/stocks/screener/
• Follow Philip A Fisher's the fifteen points to analyze the stocks that on magicformulainvesting list with Positive earnings and ROA Higher than 25% and keep them on your watch list
• Follow Philip A Fisher's when to buy advice to actually own the stocks you watched for a while
• Repeat the whole process every 3 months to see whether you need to replace the stocks with better one or add new winners in your investment portforlio
• Follow Philip A Fisher's when to sell advice to get money back to your pockets with at least 20% annual return

Magic Formula Explanation

The magic formula ranks companies based on two factors: return on capital and earnings yield.  

Return on capital=EBIT/(net working capital + net fixed assets)

EBIT was used in place of earnings allow us to view and compare the operating earnings of different companies without the distortions arising from differences in tax rates and debt levels.

Net working capital + net fixed assets (tangible capital employed) was used in place of total assets. The idea was to figure out how much capital is actually needed to conduct the company’s business. Net working capital was used because a company has to fund its receivables and inventory (excess cash not needed to conduct the business was excluded from this calculation) but does not have to lay out money for its payables. In addition to working capital requirements, a company must also fund the purchase of fixed assets necessary to conduct its business.

Earnings Yield=EBIT/Enterprise Value

Enterprise value=market value of equity(including preferred equity) + net interest bearing debt