Do Simple Stock-Picking Formulas Still Work?

Formula investing promises investors a systematic, rules-based approach to outperforming the market. In their December 2024 paper, Marcel Schwartz and Matthias Hanauer evaluated four of the most popular quantitative formulas: Joseph Piotroski’s F-Score, Joel Greenblatt’s Magic Formula, Tobias Carlisle’s Acquirer’s Multiple, and Pim van Vliet and David Blitz’s Conservative Formula. They tested their effectiveness over an extensive period and within a unified framework.

The study set out to answer a fundamental question: Do these well-known investing formulas still deliver superior returns, especially in more recent years? The F-Score is the sum of nine binary signals measuring the financial strength of a firm, distinguishing financially weak from financially strong firms among value stocks. The central idea behind the Magic Formula is to buy high-quality companies at attractive prices, identified by combining a company’s return on capital with its earnings yield. The Acquirer’s Multiple focuses solely on a stock’s enterprise multiple. And the Conservative Formula selects low-volatility stocks that exhibit the highest momentum and net payout yield.

Schwartz and Hanauer compared each formula’s performance, focusing on both raw and risk-adjusted returns. They also ,examined how these formulas provide exposure to established style factors (such as value, quality, and profitability) and whether any single formula stands out as the most effective across various metrics. Their data sample included all US common shares traded on the NYSE, NYSE American (formerly AMEX), or Nasdaq, excluding micro-caps, and spanned the period July 1963 through December 2022.

Key Findings

The investigated investment formulas are relatively easy to implement, distinguishing them from more complex and sophisticated models, such as machine-learning prediction models, which have become popular in recent years.

Against the Fama-French five-factor model plus momentum, all formulas showed negative exposure to the market factor: The top portfolio, compared with the bottom portfolio, is relatively more tilted to defensive low-beta stocks, whereas the bottom portfolio is relatively more tilted to cyclical high-beta stocks. All formulas exhibited positive exposure to the value factor and were positively correlated to the profitability factor.

All Four Formulas Delivered

Each formula produced significant raw and risk-adjusted returns, suggesting that systematic, formula-based investing remains a viable approach for generating outperformance:

• The top-minus-bottom portfolios exhibited significant annual raw returns ranging from 5.6% to 6.4%, while the CAPM alphas ranged from 7.0% to 12.2%.
• Concentrated long-only portfolios of the 40 top-ranked formula stocks also outperformed the market in the post-2000 period, both in terms of raw and risk-adjusted returns. However, all top-decile portfolios underperformed the market during the runup of the dot-com bubble between 1998 and 2000 and during the “quant winter” between 2018 and 2020, periods when value underperformed.
• The Conservative Formula stands out as the most distinct strategy, offering positive momentum exposure and consistently low volatility, making it the most defensive strategy among the four.

No Universal Winner

Despite their success, no single formula dominated across all performance metrics. In the decile analysis, the Acquirer’s Multiple exhibited the highest return for the top portfolio, while the Conservative Formula had the highest top-minus-bottom return and CAPM alpha spread.

Conversely, the Magic Formula achieved the highest remaining alpha when controlling for common asset pricing factors. For concentrated, capped-value-weighted portfolios of 40 stocks in the post-2000 period, the Magic and Conservative formulas offered the highest raw and risk-adjusted performance, respectively.

Recent Performance Decay

While all formulas continued to work for concentrated long-only portfolios after 2000, their performance has decayed compared with earlier periods. This signals that as these strategies become more widely known and adopted, their edge may diminish, highlighting the need for ongoing innovation.

Schwartz and Hanauer noted, “The findings of this study generally align with previous research and the claims made by the creators of the original formulas.”

The findings led them to conclude, “Overall, this study demonstrates that formula-based investing can still generate market outperformance, providing investors with efficient exposure to well-documented factor premiums. These strategies thus offer relatively easy-to-implement options for investors but also require investor discipline, as these strategies may underperform in the short term. As the effectiveness of these formulas has weakened in recent years, our findings also indicate the importance of continuous innovation in investing strategies.”

Key Takeaways for Investors

• Diversify Approaches: Since no single formula consistently outperforms, investors may benefit from diversifying across multiple quantitative strategies rather than relying solely on one.
• Understand Factor Exposure: Much of the success of these formulas was explained by exposure to established style factors. Investors should be aware that the formulas may not be “magic” but rather efficient ways to harness value, quality, or profitability premiums.
• Stay Adaptive: The observed performance decay in recent decades is a reminder that markets evolve. Investors using formula-based strategies should be prepared to adapt and update their approaches as formulas become more widely adopted and arbitraged away.

Summary

The formula investing study confirms that simple, rules-based investing formulas can still deliver strong returns, but there is no one-size-fits-all solution. Each formula has its own strengths, and the formulas’ effectiveness has waned somewhat in recent years.

For investors, the key is to diversify quant approaches, understand the underlying factors driving returns, and remain flexible as the investing landscape changes.

Larry Swedroe is the author or co-author of 18 books on investing, including his latest, Enrich Your Future. He is also a consultant to RIAs as an educator on investment strategies.