Investment Strategies 13: The Simple ” Magic Formula” For Indian Stocks

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:

  1. Return on assets greater than or equal to 25.
  2. P/E more than or equal to 5.
  3. 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
Ajanta Pharma 45.92 35.74 CNX500 139.24 153.21 123.51 63.15
Alembic Pharma 51.88 27.9 CNX500 121.83 132.21    
Asian Paints 56.44 31.09 CNX500 33.05 34.1 26.49 33.92
Bajaj Auto 21.68 26.04 CNX500 19.8 16.38 13.12  
Bajaj Corp 30.59 35.24 CNX500 96.55 49.48    
Britannia Inds. 76.55 50.19 CNX500 176.34 84.49 51.05 30.87
Castrol India 47.97 95.53 CNX500 52.67 23.51 16.68 25.37
Coal India 19.83 91.26 CNX500 15.27 5.88    
Colgate-Palm. 56.71 72.56 CNX500 30.57 22.43 19.72 24.87
Credit Analysis 31.53 26.57 CNX500 23.71      
CRISIL 65.62 29.63 CNX500 8.55 28.63 28.04 34.06
Cummins India 45.91 27.22 CNX500 58.29 32.83 18.06 26.16
Dabur India 72.61 30.93 CNX500 46.65 34.7 24.21 28.18
Divi’s Lab. 29.9 25.93 CNX500 29.5 21.43 20.43 30.98
eClerx Services 23.85 33.37 CNX500 23.88 30.46 27.89  
Eicher Motors 78.98 45.31 CNX500 122.22 114.19 80.83 51.4
Emami 57.76 38.15 CNX500 132.57 56.76 34.41 47.37
Glaxosmit Pharma 72.8 25.43 CNX500 38.15 17.34 11.22 14.59
GlaxoSmith C H L 48.75 27.62 CNX500 27.39 32.55 28.21 30.81
HCL Technologies 19.36 36.68 CNX500 17.81 54.2 38.13 25.14
Hero Motocorp 20.53 35.84 CNX500 1.25 8.52 6.51 15.22
Hexaware Tech. 28.4 30.69 CNX500 95.15 33.3 46.4 18.39
Hind. Unilever 50.2 115.85 CNX500 30.83 24.57 28.5 18.35
Infosys 20.71 25.31 CNX500 28.7 26.37 8.91 14.36
ITC 29.11 31.21 CNX500 -14.86 6.03 14.41 18.4
Kaveri Seed Co. 16.59 40.54 CNX500 -4.18 67.64 65.21  
Lupin 35.44 26.42 CNX500 46.33 42.41 33.86 37.22
Mindtree 19.6 26.53 CNX500 20.52 59.68 36.66  
Monsanto India 65.94 28.4 CNX500 63.99 74.71 30.74 14.74
P & G Hygiene 61.63 30.11 CNX500 37.34 40.01 23.19 24.79
Page Industries 76.56 34.01 CNX500 69.8 66.24 66.56  
Sonata Software 14.79 32.39 CNX500 92.12 102.52 24.1 17.04
Strides Arcolab 62.21 167.01 CNX500 92.01 21 24.27 17.99
Swaraj Engines 22.73 31.92 CNX500 2.33 30.89 16.98 15.92
Tata Elxsi 43.22 36.32 CNX500 170.21 98.05 44.92 23.27
TCS 22.05 42.15 CNX500 -3.18 26.89 24.13 22.95
Titan Company 38.33 25.79 CNX500 1.21 14.18 19.2 30.07
VST Inds. 21.79 43.91 CNX500 11.72 1.33 27.78 17.7
Zydus Wellness 33.78 26.83 CNX500 49.58 27.65 12.35 20.37
CAGR 51.40 45.65 33.32 28.56

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.

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