Quick Security Analysis With The Magic Formula

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Ever since its inception, my main goal with Magic Formula Investing was to find a way to outperform the market by spending as little time and money as possible. Right now, I’m currently spending about $20/mo for Morningstar Premium and using the free magic formula screen.  These two items along with Google Finance allows me to find everything I am looking for. Of course, I also use EDGAR Online to look into a company’s filings.  Now, the following magic formula investing guide is how I go about my stock picking business, by no means is this “the” magic formula guide to  magic formula investing.

Magic Formula Investing Tools

2 tools and Why?

Morningstar.com Premium – I use Morningstar Premium as my “research” site. While I do my own research by going through a company’s filings,  any nugget that I find can make a difference of whether to continue with my research or simply stop and move on. Finally, one thing about Morningstar that I like, is that they do lean towards the value investing camp. I know several other sites lean toward the value investing camp, but their sites are not as neatly laid out as Morningstar.

Main Uses:

10 Years of Financial Data (Available for free)
Interviews with known value investors
Able to see fund managers top holdings

Google Finance- As explained in my Create A Custom Magic Formula guide, Google Finance is my go to site for the day’s news. I also use Google Finance to track stocks. Now, there’s a handy little tool that will allow you to do quick and dirty security analysis in 15 seconds and determine whether a magic formula stock merits more time. And you know what the fun part is? It works for every stock.


Main uses:

Easy to keep up on a company’s story
Information is presented nicely
Easy to click on a company’s financials
Great site to do basic magic formula security analysis in seconds!!

Magic Formula Investing Security Analysis Example

i2 Technologies, Inc. (ITWO)  is our guinea pig for our example. I chose ITWO simply because it simply appeared in this past weekends magic formula stocks on the move. Underneath the stock chart for any stock, Google shows certain data is rather worthless.

We are going to make certain adjustments so we can get a quick snapshot of the company. To do this we need to click on the “Add or Remove Columns”

Remove: Price, Change, Chng %, Price History,

Keep: Company Name, Mkt Cap,

Add: P/E ratio,  Enterprise Value, Return On Avg. Assets,  Return On Investment, Net Profit Margin, EBITDA

Why These Metrics

Most of these metrics relate to the magic formula. The magic formula metrics are P/E, Enterprise Value, ROA, EBITDA. While I do not include the possibility of a takeover when making a buy or sell decision, there has been a history of magic formula stocks bring bought out and thus it helps keeping the market cap of a company in mind. Finally, the other important measure I add is Net Profit Margin. I add this column to see where the company stacks up against its competitors. I ask myself, Is it a leader? A low cost provider? If so, will they continue to be a low cot provider? can they cut fat in the company? etc… In the ITWO image above, its quite obvious the company is a leader in terms of deploying capital. It ranks high on ROA and ROI, the only other competitor with similar marks is Microsoft (MSFT), which coincidentally is a magic formula stock. While its net profit margin isn’t as high as Microsoft’s, it’s in the top half. By dividing EBITDA/EV and using E/P, I get the company’s estimated earnings yield which ranges from 4.67-7.74%. Not exactly spectacular, time to move on.

Using Morningstar 10 yr Data For Security Analysis

Many Wall Street Analyst make a big deal whether a company’s margins went up or down a couple of basis points, I don’t. there are simply too many variables in any business for a company to consistently maintain improving ratios for long periods of time. For example, and this is an obvious one, an oil company’s margin depend heavily on crude prices during that quarter/year. So what to look for, I look for some kind of consistency and how it compares to its competition, and whether it would be able to hold those margins in the foreseeable feature, 3-5 years. In the image below, it doesn’t take rocket science to figure out ITWO is all over the place and most likely doesn’t merit any more time.