Quantitative Value vs. Magic Formula Stocks

Quantitative Value vs. Magic Formula Stocks

June 11, 2012 Research Insights, Value Investing Research
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(Last Updated On: January 24, 2017)

Here is a quick screen comparison between our Quantitative Value (described here) and the Magic Formula (screen results from here):

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72

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73

Remarkably, there are only 6/30 names that overlap. In the coming months, we’ll compare the performance of Quantitative Value against the Magic Formula and see who comes out on top.

If you would like to screen names on Quantitative Value, simply sign up here and use our tool. We hope it helps your investment decision process!

 


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • Alex Brantley

    Dr. Gray, I am really enjoying Quanitative Value. I had an observation in the price ratio chapter, specifically comparing return/risk of “cheap” and “glamour” stocks (pg. 140). Is it practical to categorize the lower decile price ratios as growth? I am sure a growth investor would argue these specific price metrics are value biased so results are skewed. Curious to get your take. As an aside, I think your book should be read by all value oriented portfolio managers. I know it has given me confidence that over the long term value is rewarded in the marketplace.
    Thanks,
    Alex

  • Hey Alex,

    It is common in academic research to label the most expensive stocks “growth”. Some authors label them “glamour.”

    And yes, I’m sure growth investors would argue that their process doesn’t systematically stink, but the evidence wouldn’t agree with their sentiment. Buying expensive stocks based on ANY valuation metric hasn’t worked, historically.

  • Alex Brantley

    Quick follow up Dr. Gray – most of the fundamental data you recommend are annual figures. I am a little unsure what period to use in the probability of financial distress (PFD) variables. For example, for TLMTA do you use quarterly or annual data? In EXRET, what timeframe do you use for the stocks/index return? Finally, I am curious about the universe used. In your research did you find that increasing the universe enhanced historical performance and “risk” measured by standard deviation?
    Thanks again,
    Alex

  • In practice we use quarterly. In the book backtest I think we used annual fundamentals to keep it simple and quarterly for extret/vol, etc.

    What do you mean by “increasing” the universe? Like micro/small? The problem with ANY study involving micro/small is liquidity and data-quality so typically avoid talking about data-intensive small-cap strategies. We feel they are misleading

  • Alex Brantley

    Correct, I meant expanding the universe to include micro caps. Thanks for the quick response.

  • dph

    Do you suspect the 6 overlap stocks to show over or underperformance compared to the Magic and QV group averages?

  • yowie89

    Hello Dr Gray, I read your book Quantitative Value. I must say i am a big Fan of your investing philosophy. But there are couple of queries which i hope you could address:

    1) After mining for the top decile of value stocks sorted based on quality, Is there a way from you find a suitable entry price to buy ?

    2) Using Ebit / EV, Earnings to find the cheapest stocks, when is the cut-off point for eliminating the rest of the stocks ? Top 10% of the highest Ebit/EV ? Am i right to assume that the higher Earnings yield, the cheaper it is.

    Appreciate your reply soon.

  • 1) You buy those that are the top quality among the cheapest. You sell when they are no longer cheap and/or quality. You’ll need to figure out a rebalance period (e.g. monthly, quarterly, annually, etc.)

    2) Top 10%. If the ratio is fundamental/price, higher is better, if the ratio if price/fundamental, lower is better. This rule of thumb will hold regardless of what you put in for the fundamental or the price.

  • yowie89

    I am not too sure if i understand your meaning as Fundamental/Price. Is Ebit/EV (Earning Yield) considered that ? Do you mean Price = Ebit/EV or Price as the security price ? Apologies if i have you clarify such a simple analogy.

  • yeah, ebit/ev is a fundamental divided by a price, as is earnings / price, book / price, etc.

  • yowie89

    Thanks for the clarification, A couple of short queries,

    1. Do you exclude companies in the list without at least 8 years of reported financial data ( Gross margin, Free cash flow and etc)

    2. Due to the operations nature of some companies, the gross margin is usually high at around 100% o 90% (Usually the typical service type industries). In this case, do you use Operational Margin as a substitute so that it is more reflective ?

    Thank you for the support and appreciate the reply soon.

  • 1. Need 8 years to conduct our analysis.
    2. GM, but we calculate 2 metrics associated with his value…one benefits high stable gm firms, the other benefits firms that grow margin. We take the max score.

  • yowie89

    In your opinion, could you suggest a good database (affordable & accurate) for a retail investor like myself ? This query would probably be out of the topic ? But I would appreciate your advice.

  • our tools http://tools.alphaarchitect.com/login, thinknum, quandl, quantopian, portfolio123, moneygeek.ca…those are some i can rattle off hand.

  • yowie89

    Thanks. I will check them out. But i wanna find out how do you determine your entry price ?