1 month Update -- + 3.05 %

Well here are the hard numbers and then a few thoughts:

Bought 2/23/06

Swimmer Magic Formula Portfolio: + 3.04 %

Compare same time span:
Dow: + 2.02 %
SP500: + 1.16%
Nasd: + .71%

Best Mutual Fund Category (Domestic - Not specialty)
Small Growth: +1.54%

Best Comparison Mutual Fund Category is Small Blend:
My return would compare to top 5% of all funds in the category !

Overall the results are quite impressive - I know, 1 month means very little. But the portfolio has easily beaten pretty much all the common comparison numbers.

The most fascinating thing is that the stock I thought would do the best out of my 20 is down the most (14%). Portalplayer, on paper had the best potential to me, so good thing good thing I bought 19 others to make up for that disaster.

How to pick the Big Winners ?

I invested in 20 stocks at the same time (which I later learned is not the way to start out according the book guidelines) - but you get a wide spectrum of gains and losses.

With a little less than one month in - my biggest loser is 10% down - and my biggest gainers has raced up 32%. Most of the picks are between +/- 5% (more on the plus side - which is always good to know).

How do you find these big winners - the stock that gained 32% PWEI - has been under $3 less than 1 year ago and under $7 less than 6 month ago.

In this case - Small company - sales growth leading to sudden earnings turnaround. Sounds simple, but you tell me how to find more of these ????

A Pirate Attack !!!!

One of the stocks I had bought using the formula is PW Eagle. They do some sort of piping for houses and buildings. They have actually been the best performer over the last 2 weeks - up 14 %.

Just Friday they have been targeted by a Pirate. A very aggressive hedge fund / MA fund called Pirate Capital has bought 18% of the outstanding stocks. I usually invest in large companies - so nothing like this has ever happened to a company's stock that I own.

I was intrigued - and researched the Pirate. They are very interesting - you can find a lot about a fund like that through the very public SEC filings.
- Pirate targets smaller companies - 100 million to 1 billion market cap
-they buy 5 - 20% of the outstanding shares, sometimes working with other "raiders"
- then they pressure the hell out of the existing management - start nominating new board members and attempt to force actions that they think will enhance the stock price.
- Some of the recent targets have been WLT GY CNR -- I never heard of any of these companies either, but it is very informative to follow the actions of the management and the virtual attacks of Pirate Capital
- most of the share values have gone up quite a bit, but the history of the Pirate Fund is only about 1 1/2 years

I feel pretty good about the shares I bought using the Formula - I guess somebody else used their analysis and decided a company was very profitable and undervalued - they just have a Billion dollars to follow their ideas....

2 WEEKS IN

I now get up every morning and check the portfolio - which has increased my stress level quite a bit (and I thought I would just be able to forget about the whole thing for one year - which is the idea of the formula).

RESULTS end of market today - 03/09/2006:

MAGIC PORTFOLIO: $51,045 UP 0.6% or $305 (from 50,740)

compare to indexes:

DOW JONES: 10972 -- DOWN 1.1% (from 11093) -- GAP to Magic = 1.7% (not bad)
SP 500: 1272 -- DOWN 1.4% (from 1290) -- GAP to Magic = 1.98%
NASDAQ: 2249 -- DOWN 1.63 % (from 2287) -- GAP to Magic = 2.2%

So far so good - I guess

Best stock is up 20% - my god - PW EAGLE announced good earnings. They make some sort of plastic pipes for the housing industry and they are a big turnaround from 1 year ago - 52 week low was 2.73 now at 24.5 -- where is the formula to find those companies ?????????

Worst performer is Portalplayer - PLAY
They are down 8% (was down 10% 2 days ago). They make the semiconductor for IPODs which is about 95% of their business. If you look at their key statistics - the value of the stock makes absolutely no sense. The are growing like crazy (more than 100% over the last year), and they are making very healthy profits -- P/E ratio is 10-12 // PEG ratio of .6 for crying out loud - they have beaten their estimates 5 straight quarters and they predict good growth coming - but the stock has been dropping from 33 to 23 (I bought at 25.9). They had an IPO 2 years ago and the insiders are cashing in options like crazy -- and then they announce a key partnership with Microsoft and a huge market opportunity for laptops they are looking to be the first one into - PLUS they are still the main supplier and will be in the future for Apple IPODs and NANOs.

They have a short ratio of almost 40% of the floating shares and their average daily volume is almost 10% of the float.

I actually dropped my cash reserve of $5000 and bought more shares -- 1 day later a big Japanese fund announced that they had accumulated 15% of the shares (I think they have been manipulating the share price to buy all these shares cheap) .

Go figure - and I know it was wrong to buy more shares - but that will not be part of my MAGIC portfolio - sometimes you just go for it....

THE BUYING

I had 24 stock names - and $50,000 to invest - Plus a money market reserve of $5000 which I wanted to keep. I figured that I would start by buying about $2,000 - $2,500 per stock. I just started buying share multiples that would give me about a $2,500 value. Within 20 minutes I had 20 stocks - and I realized that for some reason I always rounded up just a little to get even numbers - so I was at about $50,700 in stocks. I moved a little more money into the account - (did not want to buy on margin) and I was done. The 4 stocks I did not buy were randomly left out. Here are the stocks and the buying price on Feb 23 or so (2 weeks ago):

Buying Price Total on FEB 23, 2006: $50,740 including transaction cost
ON SAME DAY:
DOW JONES - 11093
SP500 - 1290
NASDAQ - 2287

AEOS 25.79
CHKE 39.05
CSGS 22.14
EGY 6.42
ENDP 30.73
FCX 52.71
FTD 9.5
GBEL.OB 11.3
HAS 20.55
INSP 24.4
ITWO 15.92
KFY 20
KSWS 29.94
NTGR 17.01
PLAY 25.82
PWEI 20.34
SYNA 23.92
TBL 35.07
ULCM 11.04
UST 39.02

PICKING THE STOCKS

I thought this would be simple - just go to the website and pick the stocks. I had $55,000 to invest - so I figured about $2000 for 25 stocks and $5000 as reserve.

The website http://www.magicformulainvesting.com/ is so simple - but you still have to make choices - minimum market cap, and how many companies in the list.

My background comes into play - I have an undergrad in Business Finance and an MBA - so I know how to read financial statements - know about ratios - analysts - etc.

I tried a couple of minimum market caps and saw how the results for the companies changed - then I just settled on anything above $100 million cap (there were only very few picks below this to begin with) - the formula is supposed to work for all size market caps - but I wanted to include smaller to medium companies.

Checking out the list - no I did NOT just buy the top 25 - I had to go and see what I had there in the list - exported the list to Yahoo and checked all the ratios / headlines / and so on for the stocks.

Narrowing the List - Cherry picking - what I was not supposed to do ..
I tried using just the 25 - but I saw some immediate red flags !!! Some of the stocks had big short ratios -- more than 20% of the float out there was shorted - I kicked those out. Some companies had just announced BAD news -- I kicked those and realized I needed to start with 50 to narrow the field.

SO - There were 50 stocks I looked at - I had to narrow it down again. Short ratios - I kicked out anything that had more than 10% of the float shorted (except for one company Portalplayer -- who's stock / price / value / outlook looked so good - I just could not explain the low price - they make the IPOD semiconductors) . Kicked out anything in terms of recent news that looked funny - kicked out a few where the analysts really turned - in short anything that look strange.

I was left with about 30 stocks - so I needed to cut further. There were a lot of clothing manufacturers and energy stcoks -- and I did not want risk the exposure to focus too much on those - so I just narrowed it down and I did not pick stocks that would have earnings announcements in the next 2 days.

The entire process took me about 6 hours - not a lot of time for all the money I was investing - I finished up with 24 stcoks.

Magic Formula Investing / Little Book that Beats the Market

Here is how it started. My financial situation was good, but really in chaos.

Accounts all over the place - 4 different 401 Ks / ROth IRA from former employers and things setup in the past and ignored for a while. 6 different bank accounts (personal and small business accounts), all that required balances (which I kept in order to avoid $10 charges - while not gettting any interest on really losing money - another topic for the future). My wife had US savings bonds from her grandpa in a drawer colecting dust and earning a 4% return.

So I wanted streamline -- I walked into the local Fidelity and moved all my retirement plans and brokerage accounts to Fidelty (about $100 K) -- once this is all there (it takes weeks before these other places send the money (another future topic) I am planning to pick some good mutual funds, continue to save, and watch the money grow. But all the bank accounts resulted in $55,000 in just cash (plus we had a good end of 2005 in our business) - which I wanted to invest in stocks myself. I bought 4 different magazines, 2 of which happened to have a write-up on the Little Book that Beats the Market.

I just decided to try it out for real -- why not -- I did not have a better system -- this seemed like a simple and workable plan and I just went for it - this was around Feb 22, 2006.

The Formula (this is from another article)
What is the magic formula? Invest in good companies when they are cheap. As Mr. Greenblatt might say: See? We told you it sounded obvious. Yeah, so what's "good"? And what's "cheap"?
Good companies earn high returns on their investments, he explains, while cheap companies sport share prices that are low (based on past earnings). His proxies for these criteria are return on capital (operating profit as a percentage of net working capital and net fixed assets) and earnings yield (pretax operating earnings compared with enterprise value, which is the market value plus the net debt). To make things simpler still, his free Web site, www.magicformulainvesting.com, screens companies using his criteria. He advises individual investors to buy a basket of top stocks and turn them over on a strict schedule, depending on how they perform. (For maximum tax advantage, sell losers just before a year's up, and winners just after a year.)
It sounds too easy. But in fact, his approach is difficult not because it is hard to understand, but because it requires patience and faith that you are right when the market is saying you're wrong.
This is based on Warren Buffett's investment principles. But they bear repeating. Even a die-hard value investor like Mr. Greenblatt says he didn't realize that trying to find cheap, good companies, rather than just cheap ones, was so important until the 1990s. While Mr. Graham, Mr. Buffett's mentor, was looking for starkly cheap companies, Mr. Buffett wants only the great ones.Greenblatt's backtesting shows that buying stocks that rank highest in a combination of earnings yield (the inverse of the price-to-earnings [P/E] ratio) and return on capital have doubled the market's returns, and his website shows what stocks pass the test right now.

The Work before:
I read everything there was out there about the book - but did not actually buy the book (that seems a little stupid - I know) . But it did not really seem worth it - the website http://www.magicformulainvesting.com/ really explains all you need to know.

Concerns I learned about:
- past performance does not translate into future success.... I understand that / hear that, but I really don't buy it. When you buy stocks you buy the business prospects for the respective products and the talents of the people who work there. I used to be an athlete - you don't rise to the very top by accident.
- transaction costs, that actually worked out ok for me -- with my account the first 100 trades are only $2.95, so if I but 30 stocks it is still less than $100 or less than .2% of the total (or.4% for a buy and sell).
- people just trashing the idea -- screw them
- the long-term commitment required -- I guess time will tell... that is really all I can say.
- Cherry picking the stocks -- looking at a list of 50 stocks and then using my own "filters" to pick and choose - something the author of the picks recommends against.

NEXT POST -- Put it in action