The Little Book that beats the Market

[jIM_Ohio]

To the OP: you've got $1k/mo that you're thinking of investing in individual stocks. If your goal right now is to learn how to pick stocks, why use a "magic formula" (as they call it in the book) instead of spending time to research individual stocks? If your goal is simplicity, why not just add it to your other mutual funds? If your goal is to accept higher risk with this portion of your money in hopes of higher returns, perhaps some of the more senior investors here can suggest which avenues to pursue?

I have noticed in EnoughWealth's blog (Enoughwealth's Personal Finance Blog- Real People, Real Finances) that he is experimenting with a portion of his money in a portfolio invested according to The Little Book that Beats the Market. I'll post a comment on his blog to invite him to weigh in on this thread.

My thoughts exactly. 1k per month, IMO I would start with Dogs of the Dow strategy (15% gains annually, on average), then branch out into small caps once you can handle the volatility.

If you can find the next MSFT before it becomes a large cap, the run up will yield you much more than 30%. IMO the goal with "extra" is to find a home run (if all other savings plans is on track).

My initial mistake with investing was shooting for home runs before I had a good allocation in place behind it.

[enoughwealth]

Looks good in theory...

Hi,

I've been investing in one stock picked from the list of prospects thrown up using using 'Little Book That Beats The Market' "magic" formula (Magic Formula Investing) each month since last June. I plan on adding 1 stock (approx. $5,000 worth) each month over an 18 month period, then sell the oldest stock each month and buy a replacement stock from the current "list" of prospects. This will result in a total portfolio of 18 US stocks with a portfolio value of around $90,000 when fully invested.

I'm using a "portfolio loan" (ie. a home equity LOC) to fund these purchases, so the total ROI has to exceed my borrowing costs in the long term for this to be worthwhile. I'll stick with this plan for 10 years and then evaluate how well it's been performing. The quoted average annual return of around 30% is very high compared to average stock index performance (so I don't expect to achieve this) - but is theoretically possible if you managed to mainly pick "winners" and (more importantly) exclude all bit a few "losers" from the portfolio. My cost of funds is around 8%, so I'm hoping to acheive 10% or more using the "Little Book" filtering to identify stocks for me to invest in.

The author appears to have good academic credentials, and the analysis method underlying the "magic formula" is basically a fundamental value analysis, which is what I would attempt to do myself to analysis individual US stocks (if I had the time and access to all the data). Back-testing never provides any guarantee of future performance, regardless of how far back you go -- and there is always the liklihood that data from different periods is less relevant to predicting the next 10-30 year period the further back you go ie. it is reasonable to assume that company performance in the next 10-30 years will have more in common with the last 10-30 years than for the period 1920-1950 for example. If nothing else, management techniques and accounting standards have changed considerably compared to more than 30 years ago. However, the main reason I think the back-testing only goes back 17 years is that not all the required data was available for earlier periods, so no meaningful analysis could be done.

Bear in mind that my NW is around $1m AUD, and my Australian stock portfolio (geared with a LVR of around 50%) is currently worth around $625K, so when fully invested my "Little Book" US stock portfolio will only be around 5.5% of my total investments and around 12.5% of my direct stock investments. Therefore this is a small, highly speculative portion of my total investment allocation, and is assumed to be high-risk, high-return. While a ROI of 30% on this investment could add significantly to my overall portfolio ROI over the next 10-20 years, a poor ROI (say 0-5%) would not have a huge impact on my total portfolio performance.

I think my target return of around 10%+ is quite reasonably considering the total ROI of the US stock market as a whole - I see no reason why a diversified portfolio of 18 stocks picked using prospects thrown up each month using the "Little Book" rankings should underperform the index (and has a reasonable chance of overperforming, though I doubt it will achieve 30%+!)

I would NOT use this as my principle investment method for my entire stock portfolio - after 20 years of doing direct stock investment myself (based on a mix a fundamental analysis, broker recommendations and a glance at the charts), I've ended up focusing mainly on asset allocation and the use of low-cost index funds for the "core" of my investment portfolio. I still dabble with actively managed funds for hard-to-invest in assets (eg. BRIC, emerging markets, hedge funds) to achieve my desired overall asset allocation, and do some direct stock investments mainly as an interesting "hobby".

If you're interested in seeing my monthly stock additions to my "Little Book" portfolio, and how my particular implementation of such a portfolio is progressing each month, you can check out my posts on Enough Wealth (also mirrored here at http://enoughwealth.savingadvice.com).

Regards
Enough Wealth

[Broken Arrow]

I would NOT use this as my principle investment method for my entire stock portfolio - after 20 years of doing direct stock investment myself (based on a mix a fundamental analysis, broker recommendations and a glance at the charts), I've ended up focusing mainly on asset allocation and the use of low-cost index funds for the "core" of my investment portfolio.

Thank you for injecting this little piece of common sense. In the long run, there is no such thing as a "magic bullet" in investing, but there's nothing wrong with hedging on... just about anything, so long as it's done within the proper context of your asset allocations.

[jIM_Ohio]

I smell a troll?