HAUGEN SYSTEMS PORTFOLIO BACKTESTS

In this backtest, known as the Rosetta Stone Backtest, we set out to replicate the strategy presented in

The Little Book. For the first factor, Return on Capital, we used the ratio of the trailing 12 month's EBIT divided

by Net Operating Assets (the sum of property, plant, equipment and total current assets, less total current

liabilities). For the second factor, Earnings Yield, we used the trailing 12 months EBIT divided by Enterprise

Value. Just like in the book, we ranked these ratios and combined the rankings for a cumulative score.

We then constructed portfolios with 30 stocks, making sure not to include any stocks from the

Finance and Utility sectors. We also used the population of the top 1,000 stocks by market capitalization.

While Greenblatt did not say exactly how he constrained for liquidity, the top 1,000 stocks have very few,

if any, low-liquidity stocks. The portfolio was then held for one year without any monthly balancing.

Once the backtest was complete, we linked the returns to get annualized results. Then we ran 11 more tests,

with each test beginning in a different month. For example, to see how the strategy would do if the test began in

February, we formed a portfolio of 30 stocks beginning in February, 1997; held the stocks for one year, and

linked the returns.

The following worksheet presents the results from all 12 backtests for this methodology along with several other

methodologies. These other methodologies used similar factors to Greenblatt's, in order to see how GARP

investing would have done in general. But otherwise we did not make an attempt to replicate Greenblatt's strategy

in these other strategies; for example our return on assets factor does not include earnings before interest and

taxes, but is rather the ratio of operating income to assets. In addition, our earnings yield does not use enterprise

value, but is rather the ratio of the most recently reported 12 months earnings per share to the current market price.

Finally, the last two worksheets graphically show how the cumulative returns from five selected methodologies

performed over the time period of the study