Does the Magic Formula work on the ASX?
Introduction I recently read Joel Greenblatt’s The Little Book that Still Beats the Market and was intrigued by the Magic Formula. It seemed far too simple to generate the returns it claimed yet there seemed to be an abundance of studies backing its success. After delving into some of the blogs/articles/papers on the formula, I was surprised by the lack of research on the formula's performance within Australia, especially given the maturity of the ASX. So, I decided to give it a fair crack and share the results. The Magic Formula Simply put, Greenblatt's formula recommends the following: Screen for companies with a market cap over $50 million and rank each company's earnings yield and return on capital. Combine the ranks to form a "cheapness to value” score (rank 1 = company with lowest yield rank + ROC rank). Pick the top 30 companies with the lowest score and hold them for a year. At the end of each year, sell any depreciated stocks before the 12-month mark to harv...