The Magic Formula screen which I run each year, based on the simple screening strategy set out by Joel Greenblatt in his classic text 'The Little Book That Beats The Market', has produced truly 'magic' returns on a number of occasions. However, 2014 was not one of them. The top 10 shares picked by the screen last year produced a negative total return of 5.3 per cent, the top 15 a negative 0.3 per cent, the top 20 a positive 2.8 per cent and the top 30 a negative 0.4 per cent. These dismal returns compare with 9.3 per cent from the FTSE All-Share.
Part of the underperformance from the screen can be explained by the fact that, while I use a £50m minimum market cap limit, many of the shares selected by the screen hail from the Aim market, and Aim has had a lousy year. Some of the most terrible performers from last year's share picks, such as Chinese fashion company Camkids (CAMK), heralded from the junior market (see table). This year 43 per cent of the shares picked by the screen come from Aim. These include some contentious stocks such as Quindell (QPP) as well as a number of resources companies. The other thing to bear in mind when considering 2014's poor showing is that Mr Greenblatt never pitched his screening method as one that would produce consistent outperformance. His idea was that if the screening process was stuck to rigidly over time, it would outperform in the long term while hitting a few bumps along the way. And the 2014 bump comes after very impressive results in 2011, 2012 and 2013.
2014 and 2013
| Name | TIDM | Total return (4 Feb 2014 - 10 Feb 2015) | Name | TIDM | Total return (6 Feb 2013 - 3 Feb 2014) |
| Connect | CNCT | -16.6% | Creston | CRE | 13.4% |
| Qinetiq | QQ. | -12.3% | UTV Media | UTV | 92.8% |
| Go-Ahead | GOG | 27.6% | GemFields | GEM | 30.0% |
| Alliance Pharma | APH | 5.6% | Impellam | IPEL | 27.6% |
| Camkids | CAMK | -69.9% | Xchanging | XCH | 45.6% |
| Creston | CRE | 25.9% | Naibu Global | NBU | -38.4% |
| Johnston Press | JNPR | -48.8% | Chime Comms | CHW | 46.1% |
| BAE Systems | BA. | 29.6% | M&C Saatchi | SAA | 51.0% |
| Central Asia Metals | CAML | -9.9% | AstraZeneca | AZN | 33.8% |
| William Hill | WMH | 15.8% | Brightside | BRT | -20.7% |
| Soco International | SIA | -23.9% | Homeserve | HSV | 40.2% |
| Management Consultancy | MMC | -37.6% | WS Atkins | ATK | 68.8% |
| Ladbrokes | LAD | -14.7% | Alternative Networks | AN. | 95.9% |
| Next Fifteen Comms | NFC | 80.9% | GVC | GVC | 46.5% |
| Imperial Tobacco | IMT | 43.9% | WH Smith | SMWH | 58.0% |
| Huntsworth | HNT | -37.7% | Qinetiq | QQ. | 14.8% |
| British American Tobacco | BATS | 30.6% | Anglo Asian Mining | AAZ | -63.3% |
| Homeserve | HSV | 9.3% | Alliance Pharma | APH | 5.5% |
| Rank | RNK | 37.6% | Go-Ahead | GOG | 56.2% |
| AstraZeneca | AZN | 20.8% | Coastal Energy | CEO | -25.9% |
| Kentz | KENZ | 43.4% | Cable &Wireless Comms | CWC | 36.8% |
| Andrew Sykes | ASY | -6.5% | Gable | GAH | 53.8% |
| Carrillion | CLLN | 11.0% | Vp | VP. | 109.9% |
| KBC Advanced Tech | KBC | -15.1% | MDM Engineering | MDM | -9.2% |
| Commuisis | CMS | -20.5% | Next Fifteen Comms | NFC | -5.8% |
| Afren | AFR | -93.7% | Amara Mining | AMA | -73.1% |
| Harvey Nash | HVN | -27.2% | Kcom | KCOM | 33.5% |
| WH Smith | SMWH | 26.9% | Ebiquity | EBQ | 23.3% |
| Games Workshop | GAW | 4.5% | Afren | AFR | -3.5% |
| Ebiquity | EBQ | 9.7% | Immud. Systems | IDH | 87.4% |
| FTSE All-Share | - | 9.3% | FTSE All-Share | - | 9.0% |
| Greenblatt top 10 | - | -5.3% | Greenblatt top 10 | - | 28.1% |
| Greenblatt top 15 | - | -0.3% | Greenblatt top 15 | - | 39.4% |
| Greenblatt top 20 | - | 2.8% | Greenblatt top 20 | - | 28.9% |
| Greenblatt top 30 | - | -0.4% | Greenblatt top 30 | - | 27.7% |
2012 and 2011
| Name | TIDM | Total return (7 Feb 2012 - 5 Feb 2013) | Name | TIDM | Total return (28 Jan 2011 - 7 Feb 2012) |
| Impellam | IPEL | 41.9% | Education Dev. | EDD | 76.0% |
| Xchanging | XCH | 55.7% | JD Sports Fash. | JD. | -5.7% |
| Alliance Pharma | APH | 8.1% | AstraZeneca | AZN | 4.7% |
| Pace | PIC | 158.8% | JKX Oil & Gas | JKX | -50.4% |
| Anglo Asian Mining | AAZ | 11.0% | Pan African Resources | PAF | 79.4% |
| AstraZeneca | AZN | 8.7% | Andrew Sykes | ASY | 12.6% |
| UTV Media | UTV | 21.5% | Paypoint | PAY | 74.0% |
| WS Atkins | ATK | 17.9% | Next | NXT | 38.0% |
| GVC Holdings | GVC | 88.9% | Timeweave | TMW | 6.4% |
| Ferrexpo | FXPO | -24.0% | FW Thorpe | THRP | 15.7% |
| JD Sports Fash. | JD. | -4.4% | Matchtech | MTEC | -6.9% |
| Halfords | HFD | 13.1% | Eaga | EAGA | 73.5% |
| Immud. Systems | IDH | -20.0% | Anglo-Eastern Plant. | AEP | -0.6% |
| William Hill | WMH | 74.6% | China Shoto | CHNS | 31.1% |
| Logica | LOG | 31.1% | Sportingbet | SBT | -16.9% |
| Howden Joinery | HWDN | 76.3% | Howden Joinery | HWDN | -2.3% |
| Valiant Petroleum | VPP | -11.3% | Pace | PIC | -50.0% |
| Gemfields | GEM | 29.2% | WH Smith | SMWH | 14.7% |
| Quinteq | QQ. | 45.6% | Jetion Solar | JHL | 0.0% |
| Laura Ashley | ALY | 40.4% | Halfords | HFD | -15.1% |
| Anglo Pacific | APF | -9.4% | Alternative Networks | AN. | 58.7% |
| WH Smith | SMWH | 33.1% | Alliance Pharma | APH | -9.2% |
| Next Fifteen Comms | NFC | 8.8% | Laura Ashley | ALY | 0.6% |
| XP Power | XPP | 13.0% | Micro Focus | MCRO | 12.7% |
| Clarkson | CKN | 23.4% | Greggs | GREG | 16.3% |
| Gulfsands Petroleum | GPX | -38.2% | Griffin Mining | GFM | -31.5% |
| Kcom | KCOM | 11.3% | Robert Wiseman | RWD | 20.4% |
| BHP Billiton | BLT | 2.9% | James Halstead | JHD | 23.9% |
| Andrew Sykes | ASY | 12.4% | BHP Billiton | BLT | -5.5% |
| GlaxoSmithKline | GSK | 8.4% | - | - | - |
| FTSE All-Share | - | 12.5% | FTSE All-Share | - | 2.6% |
| Greenblatt top 10 | - | 38.8% | Greenblatt top 10 | - | 25.1% |
| Greenblatt top 15 | - | 32.2% | Greenblatt top 15 | - | 22.1% |
| Greenblatt top 20 | - | 33.2% | Greenblatt top 20 | - | 13.9% |
| Greenblatt top 30 | - | 24.3% | Greenblatt top 30 | - | 12.6% |
Source: Thomson Datastream
Given the strong run from the screen prior to 2014, the cumulative return since I began running it in early 2011 is still strong. For the 10 stock portfolio the return is 109 per cent, for 15 stocks 123 per cent, for 20 stocks 100 per cent and for 30 stocks 78 per cent. This compares with 37 per cent from the FTSE All-Share over the same period. Add in a 1.5 per cent charge to take account of dealing costs and the return falls to 98 per cent for 10 stocks, 111 per cent for 15, 89 per cent for 20, and 68 per cent for 30.
Source: Thomson Datastream
The concept behind the screen is straightforward enough: to find cheap shares in good companies. The real beauty of the screen is the succinctness with which this idea is applied, using just two formulas.
The question of cheapness is addressed using an earnings yield (EY). An EY is effectively a price-to-earnings (PE) ratio turned on its head. It expresses a company's earnings as a percentage of its market capitalisation (or share price if we're using earnings per share EPS). However, Mr Greenblatt's EY formula does not use the after-tax earnings that are commonly used when calculating a PE ratio. Instead, Mr Greenblatt is interested in the underlying operational performance of a business before interest charges and tax rates are applied, which can vary markedly from company to company. The EY formula he advocates using is therefore based on looking at earning before interest and tax (Ebit) - also often known as operating profit - as a percentage of market capitalisation.
To assess how good a company is, Mr Greenblatt looks at how efficient it is at generating earnings using return on tangible assets. This attempts to measure how much profit a company is generating from its productive asset base. This profit can then be returned to shareholders or, if growth opportunities are available, reinvested in new assets to generate more profit.
The formula Mr Greenblatt uses to measure the returns being achieved by a company strips down the balance sheet to focus in on the part of the company's asset base that is being used in its day-to-day operations. The return-on-tangible-assets formula does this by looking at a company's Ebit as a percentage of its net working capital plus net fixed assets. The short hand calculation for net working capital, which I have used for this screen, is to subtract current liabilities from current assets. One weakness with this method is that any cash a company is holding is included in the calculation and this is not actually a productive asset. Meanwhile, net fixed assets are fixed assets (also known as property, plant and machinery) less accumulated depreciation.
The screen itself works by ranking the shares from highest to lowest EY and highest to lowest return on tangible assets. The screen then finds the stocks with the best combined rankings. Mr Greenblatt believes it is best to make a portfolio of the top 20 to 30 stocks from the screen. He also advocates building up the portfolio on a quarter-by-quarter basis over a year, taking the top performing shares from the screen each time. However, given that I run the screen on an annual basis there are no such subtleties here. Below are a list of the screen's top 30 results for this year.
| Name | TIDM | Mkt cap | Price | Fwd NTM PE | DY | 3-mth mom |
|---|---|---|---|---|---|---|
| Lamprell | LSE:LAM | £387m | 113p | 8.0 | - | -21.5% |
| Amerisur Resources | AIM:AMER | £340m | 32p | 11.7 | - | -35.2% |
| Nighthawk Energy | AIM:HAWK | £68m | 7p | 10.1 | - | 10.6% |
| Quindell | AIM:QPP | £313m | 72p | 1.2 | 2.1% | -5.3% |
| Marimedia | AIM:MARI | £90m | 140p | 12.0 | 6.8% | -7.5% |
| Johnston Press | LSE:JPR | £179m | 170p | 6.7 | - | -6.2% |
| KBC Advanced Tech | AIM:KBC | £71m | 88p | 11.9 | 1.1% | -7.5% |
| Somero Enterprises | AIM:SOM | £65m | 115p | 9.6 | 1.7% | -2.6% |
| Management Consulting | LSE:MMC | £75m | 16p | 13.1 | 5.3% | -10.8% |
| Globo | AIM:GBO | £172m | 46p | 6.5 | - | 12.6% |
| Central Asia Metals | AIM:CAML | £166m | 149p | 7.5 | 6.7% | -5.4% |
| XLMedia | AIM:XLM | £128m | 64p | 14.7 | 3.3% | 43.8% |
| SOCO International | LSE:SIA | £967m | 295p | 15.1 | - | -13.5% |
| Nostrum Oil & Gas | LSE:NOG | £1,039m | 552p | 11.5 | 4.2% | -18.9% |
| Gem Diamonds | LSE:GEMD | £207m | 150p | 9.9 | - | -13.6% |
| Xaar | LSE:XAR | £259m | 346p | 16.8 | 2.3% | 19.8% |
| Stock Spirits | LSE:STCK | £396m | 198p | 13.6 | 0.9% | -18.9% |
| Ferrexpo | LSE:FXPO | £354m | 61p | 2.3 | 14.3% | -21.1% |
| Immunodiagnostic Systems | AIM:IDH | £95m | 325p | 0.0 | 2.6% | 4.7% |
| KCOM | LSE:KCOM | £441m | 86p | 11.3 | 5.7% | -7.6% |
| Synthomer | LSE:SYNT | £827m | 244p | 12.5 | 2.5% | 14.9% |
| Hargreaves Services | AIM:HSP | £184m | 574p | 5.6 | 4.5% | -11.4% |
| Alliance Pharma | AIM:APH | £90m | 34p | 10.7 | 2.7% | 7.3% |
| Antofagasta | LSE:ANTO | £6,837m | 694p | 15.1 | 9.0% | -2.7% |
| Clarkson | LSE:CKN | £405m | 2,016p | 15.8 | 2.8% | -8.9% |
| Hunting | LSE:HTG | £740m | 506p | 9.2 | 3.8% | -29.0% |
| John Wood | LSE:WG. | £2,208m | 605p | 9.9 | 2.4% | -10.6% |
| Petrofac | LSE:PFC | £2,654m | 780p | 7.8 | 5.5% | -30.9% |
| Vertu Motors | AIM:VTU | £199m | 58p | 11.8 | 1.4% | 0.9% |
| Salamander Energy | LSE:SMDR | £215m | 83p | - | - | -17.3% |
Source: S&P Capital IQ
