Monday, December 19, 2011

The magic formula in New Zealand

The bookbookfund doesn't invest in New Zealand equities, but I do on my personal account. Ever since I read Joel Greenblatt's The Little Book That Beats The Market I've been interested as to how his "magic formula" would work in New Zealand.

Briefly, the magic formula is:

Establish a minimum market capitalization (usually greater than $50 million).

Exclude utility and financial stocks.

Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages).

Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period.

Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.

Continue over a long-term (3–5+ year) period.

I got hold of New Zealand stock market data here.

With that data, I ranked all the stocks by earnings yield and by return on invested capital, aggregating their rankings and then ranking the aggregate (to get the best "combo"). Then I created portfolios of ten stocks a piece (if you buy 30 you may as well buy the whole NZ market), starting January 2004 (where I have data back to), to the present day. I only rebalanced every year, in January.

I used sharesight to input the portfolios, as that site then gives me all the dividends so I can count those too as well as any capital gain.

There was corrupted data from the Stern University NZ data for 2007 so I was not able to rebalance on January of that year (I had to keep my 2006 portfolio for two years instead of one). There were a few other issues when inputting data where I had to use a second choice, but I still got plenty of big winners and big losers.

Overall, from 1 January 2004 to the present day, the "magic formula in NZ" strategy returned a 8.93% cumulative annual growth rate. My first fake portfolio had $150 000 worth of shares at the start of 2004, and with annual rebalancing (except for 2007) it has a current value of $296 508. Not bad, but not particularly astounding.

But I checked the return of the smartFONZ index fund over that period. Unfortunately, this exchange traded index fund didn't start until part way through 2004. To account for this, I took the value of the magic formula portfolio at Jan 2005 ($181 486) and pretended that instead of persisting with the magic formula strategy, I simply purchased the index fund and waited. That strategy returned 0.6% cumulative annual growth rate (including dividends), and that's including the $31 486 advantage from using the magic formula in its first year! Compared to that terrible growth, the magic formula looks pretty magical.

This was a very rough experiment: none of the data or methods I used were particularly sound. I found the best free excel ready data I could, and used sharesight - a pretty powerful portfolio tracker.

If I make further investments in the NZ sharemarket, I'll definitely be looking at where potential companies rank in the "magic formula".

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