Value Investing Backtesting Greenblatt's Magic Formula |
Backtesting Greenblatt's Magic Formula Posted: 08 Jun 2020 06:03 AM PDT Over the past week I've been researching various systematic equity strategies and decided to backtest Joel Greenblatt's Magic Formula, discussed in The Little Book That Beats the Market. Result: between 2003 and 2015, the Magic Formula strategy returned an annualised 11.4% (Sharpe ratio 0.60), versus 8.7% for the S&P500 (Sharpe ratio 0.54). This corresponds to a 3% alpha, so the Magic Formula does indeed outperform the market. What is the Magic Formula? A very brief summary is as follows (the exact procedure described in the link): rank stocks by Return on Capital (a measure of quality) and also by earnings yield (a measure of cheapness). Add the ranks to create a score that takes into account both quality and cheapness, then pick the top stocks. In The Little Book, Greenblatt suggests that the Magic Formula returned an annualised 33% from 1988 to 2004 compared to 14% for the S&P500. My investigation shows that while there is some outperformance on a risk-adjusted basis, it is nowhere near as much as Greenblatt suggests. I think this is due to the arbitraging force of systematic equity ETFs as well as a possible regime shift post-2008. Other insights from the backtest
About the backtest I built the backtest in python on the Quantopian platform. I first analysed the predictive power of the Greenblatt score and since the results were good, moved on to construct a proper backtest that includes transaction costs and follows Greenblatt's accumulation procedure. The only reality not captured by the backtest is tax optimisation. More information I have written a blog post containing more information, including potential modifications if you wanted to use it for personal investing. The full backtest report is on GitHub – you can download the html and open it with any browser. Always happy to hear any feedback, questions or criticism! EDIT: backtest up until June 2019 as requested by u/flyingflail (can't go any further due to data limitations). It turns out that the 2015-2019 time period is terrible for the strategy. Significantly underperforms the market. A good reminder that past performance is not indicative of future results! [link] [comments] |
Stanley Druckenmiller Says He’s Been ‘Humbled’ by Market Comeback, Underestimated the Fed Posted: 08 Jun 2020 06:21 AM PDT |
You are subscribed to email updates from Value Investing. To stop receiving these emails, you may unsubscribe now. | Email delivery powered by Google |
Google, 1600 Amphitheatre Parkway, Mountain View, CA 94043, United States |
No comments:
Post a Comment