In the bestselling book 'The Little Book that Beats the Markets', Joel Greenblatt describes a 'magic formula' for selecting stocks that will in the long run beat the index. The idea is that high quality companies become undervalued and the formula allows the investor to finds these companies and put together a 20-30 member portfolio of the highest ranked stocks, which is rebalanced just once a year.
James Montier subsequently published a paper 'The Little Note that Beats the Markets' where he applied the magic formula to the US, Europe, UK and Japan markets from 1993-2005. The results shows the Little Book strategy handsomely beats a 30-stock equal weighted index in all regions with lower volatility. Interestingly he reports replacing the two value metrics used in the formula EBITDA/EV and ROC with the more standard Earnings yield (E/P) and ROA also beats the indices but with lower returns.
Out of curiousity I have applied this modified magic formula (E/P & 5-year ROA) to the 39 mid and large cap companies (>$2Bn market cap) in the Spanish stock market.
James Montier subsequently published a paper 'The Little Note that Beats the Markets' where he applied the magic formula to the US, Europe, UK and Japan markets from 1993-2005. The results shows the Little Book strategy handsomely beats a 30-stock equal weighted index in all regions with lower volatility. Interestingly he reports replacing the two value metrics used in the formula EBITDA/EV and ROC with the more standard Earnings yield (E/P) and ROA also beats the indices but with lower returns.
Out of curiousity I have applied this modified magic formula (E/P & 5-year ROA) to the 39 mid and large cap companies (>$2Bn market cap) in the Spanish stock market.
What follows is a list of the top 10 'high quality' stocks that have a low valuation.
I will not go into the details of each company, that is not the point of the Little Book strategy. The portfolio is constructed purley on the output of the formula and not subjected further to 'active management' by the investor.
However, we can see two companies on the list are in the construction services and another in real estate operations, which I assume is due to the collapse in Spanish property prices. Buying these would be a bet that the markets are overly pessimistic and property prices outperform expectations.
Indra Sistemas looks interesting as it is a computer services company and it's not obvious at first glance why the current finanical 'crisis' in Spain would affect this stock. To see if it is being unfairly undervalued let's compare it to its peers in Germany, France and UK
Indra clearly has a far lower P/E ratio with a significantly higher dividened yield and a similar ROA. Does this mean it is of simliar quality to its peers but undervalued?
Of course, on further digging there may be a very good reasons as to why Mr Market is not keen on this stock thus making it a 'value trap'. However, it does pose the question if some Spanish stocks are being unfairly punished and being dragged down by the market as a whole and macroeconomic news.
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