What are we looking for?
Yesterday we checked in with our Magic Formula portfolio of U.S. stocks and discovered - to our delight - that it's handily outperforming the S&P 500. Today we'll see how our Canadian portfolio is doing.
In February, we asked CPMS, an equity research and portfolio analysis firm owned by Morningstar Canada, to help us search for Canadian stocks that meet the Magic Formula criteria.
What is the magic formula?
U.S. money manager Joel Greenblatt detailed his strategy in The Little Book that Beats the Market. His formula aims to find companies that are both profitable and cheap by focusing on two measures: return on capital and earnings yield.
The higher the return on capital - which he defines as pretax operating profit divided by the sum of net working capital and net fixed assets - the more effectively a company is using its capital to generate profit.
The higher the earnings yield - defined as pretax operating profit divided by enterprise value, or the sum of stock and debt - the more attractive the stock is from a valuation standpoint.
CPMS screened its full database of 661 Canadian stocks but filtered out those with a market capitalization of less than $100-million. It also filtered out stocks with negative working capital or fixed assets of less than $1 per share, as these would distort the return on capital values.
Finally, mirroring Mr. Greenblatt's methodology, CPMS left out financial and utilities stocks, because their unique accounting statements don't play well with the Magic Formula.
Our Canadian portfolio is up 6 per cent from Feb. 12 through April 12, excluding dividends. That compares with a gain of 5.9 per cent for the S&P/TSX composite index over the same period.
Two months isn't long enough to judge the performance of any strategy. We'll check back every few months to see how the portfolio is faring.