Many of you must know the popular book: The little book that beats the market by Joel Greenblatt. This strategy is based on a simple formula that Greenblatt talks about at the end of the book. He says that if you are using any other screener than his magic formula website you should use the following criteria:
- Return on assets greater than or equal to 25.
- P/E more than or equal to 5.
- Eliminate all utilities and financial stocks (i.e., mutual funds, banks, and insurance companies) from the list.
Although this formula was written for US stocks, I think you can also apply it to any country, as the principles of value investing are universal.
Use this formula on the S&P CNX 500 which is a broad-based index of the Indian stock market like the S&P 500. This index represents about 95.77% of the free float market capitalization of the stocks listed on NSE as on March 31, 2015. The total traded value for the last six months ending March 2015, of all Index constituents is approximately 91.97% of the traded value of all stocks on NSE. So this is really a broad index.
The stocks the formula selects today are:
|Company Name||Price-Earnings Ratio||PAT / Total Assets||Index||1 yr return||3 yr return||5 year return||10 year return|
|GlaxoSmith C H L||48.75||27.62||CNX500||27.39||32.55||28.21||30.81|
|Kaveri Seed Co.||16.59||40.54||CNX500||-4.18||67.64||65.21|
|P & G Hygiene||61.63||30.11||CNX500||37.34||40.01||23.19||24.79|
The trailing returns of these stocks are:
- 1 year=51.4% ( CNX 500 return=12.5%)(Franklin Prima Plus=31.5%)
- 3 year= 45.7%(CNX 500 return=20%)( Franklin Prima Plus=28.2%)
- 5 year=33.3%( CNX 500 return=9.2%)( Franklin Prima Plus=16.7%)
- 10 year=28.6%( CNX 500 return=13.1%)( Franklin Prima Plus=19.9%)
Here is the excel sheet for the above data: CNX 500 Simple Magic Formula Stocks
So these stocks have handily beaten the index and very good active mutual funds in the past. But this is not a right comparison as these stocks may not have been selected in the past and may not have been in the CNX 500 index. Yes, that is true. But when you look at the companies, a lot of them are well-known companies with strong brands and possibly pricing power. And if you invest in the whole basket, you are most likely to do well in the long run of 10-20 years. Likely, not definitely.
Therefore, you may want to consider a strategy like this, provided you are willing to stick with it for the long run. Like getting married to the strategy, no matter what. Otherwise, it may be better to stick with well diversified mutual funds using a systematic investment plan.