MFI and the market correction

Sometimes it's better to be lucky than smart -- sometimes it's better to be lucky than good at a particular task. I play a little bit of online poker for small stakes and if there is one thing you learn in poker it is that "luck can beat good play any day - any time".

Why is this relevant to investing -- well, you can do all the research and pretend to have these great market insights, but very often, a little bit of luck can change your fortune. Of course, similiar to the poker example, in the long run, good play should and probably will prevail - but one should always remember, that there is an element of chance or just pure luck.

Why is this relevant to my portfolio -- I got up on Monday morning on the 1 year and 2 day anniversary of my Magic Formula Investing start and sold 7 of my top gainers for the one year. While I considered to replace them right away, my target stocks all seemed to have been on a little bit of a run (maybe that was a sign) - so I was waiting on a "dip" (always be careful what you wish for). So I only replaced 2 of the 7 stocks and left about 20% of my portfolio in cash. Of course Tuesday was the meltdown and I got very lucky in terms of market timing - there was no skill, no reading of the market conditions or anything like that. So now, I can wait a couple of more days and let things calm down to look for stocks that just experienced the "dip" I was hoping for.

Did FCX win the Lottery ?

I had an idea for a new posting - this may be interesting.

I thinkthere is always a reason that any stock shows up on the MFI list. It may be fun / interesting to talk about the various reasons stock by stock.

Let me start with this one - FCX - has been on the top 25 MFI ever since I first looked at the list and I actually have the stock for a year now. Why are they on the list ?

- Copper and Gold prices

I am not a stock analyst or financial expert - but it seems rather simple in this case - FCX has been around for 100 years or so - they mine Copper and Gold - the stars have aligned and copper prices went through the roof (gold as well - i think). Don't know much about details for the commodities market - but I know prices will even out eventually.

The only other question is - what is FCX doing with it's cash windfall ? Looks like they are buying a competitor - PhelpsDodge (also on the list). I don't know - but that reminds me of a lotto winner going on ashopping trip >>> I think I am selling this week (my year is up).

More Information for Magic Formula Investing - 1 year

Here are some detailed numbers of my portfolio compared to the SP500 -- the first number always represents my Portfolio and the 2nd is the SP 500 --- PLEASE COMMENT - I AM VERY INTERESTED IN OTHER OPINIONS HERE :

Stock Sectors - No real surprise here -- very much within the ranges.:
Information
20.79 19.98

Service
42.8 46.76

Manufacturing
36.40 33.25

Within Information - some differences, but I think one stock could make those differences:
Software 9.68 3.49
Hardware 6.18 9.53
Media 3.08 3.46
Teleco 1.84 3.50

SERVICES - of course no financial services - seems like that all goes towards business services
Healthcare 11.91 12.71
Consumer Services 10.96 7.72
Business Services 19.94 4.06
Financial Services 0.00 22.27

Manufacturing - little surprise here - I figured I would have more Energy stocks:
Consumer Goods 19.00 8.64
Industrial Materials 13.72 11.89
Energy 3.68 9.32
Utilities 0.00 3.40



STOCK TYPE -- lots of speculation - which I am not sure that makes sense. To me speculative stocks show future promise - but the screen makes sure these stocks do give a solid return ???

High Yield 15.03 12.23
Distressed 5.71 0.35
Hard Asset 6.81 10.54
Cyclical 11.44 11.26
Slow Growth 17.38 12.13
Classic Growth 16.70 40.20
Aggressive Growth 2.38 9.76
Speculative Growth 24.55 2.86

The last set of numbers -- SP 500 = 1
These are the most telling set of numbers. Forward PE ratio is the same as SP 500. That is somewhat surprising - the size of my companies is very small and 1/4 of them are spec. growth stocks. Then the projected EPS growth is 1.28 -- again that seems very solid. Price / Book ratio - this is where the MFI screens really start showing 2.58 vs. 1 - BIG difference. ROA is better and of course ROE should be very good - 1.61 vs 1 .

Price/Earning Forward 14.69 0.97
Projected EPS Growth - 5 yr % 14.25 1.28
Price/Book Ratio 2.58 1.01
Yield % 1.31 0.81
Return on Asset (ROA) 14.25 1.32
Average Market Cap $mil 760.37 0.02
Return on Equity (ROE) 31.69 1.61

Magic Formula Investing Anniversary - Overall Return

I know - I am celebrating too often for my 1 year anniversary - but yesterday was the actual date - and I got lots of numbers to throw around:

Return of the original 20 purchases = 31.2%
Index comparison are at about 15%
Mutual Fund comparison would be Small Blend -- Category 1 year return is 12.8%

I bought more stocks as the year went so my current actual overall portfolio is at 29.1%. If I would have bought with equal $ amounts throughout the year, I would be at 25.4% ( you can see that I got a little lucky with the Feb purchases) - that is a number many mutual funds use when they do their returns.

The overall return numbers are VERY good -- there are only 2 mutual funds in the Small Cap category that have done better than 30%. And even the 25% number would still be in the top1% for mutual funds in that category - with expenses at.25%

No need to say that I am moving ahead with my Magic Formula investments - although I am not expecting (of course one can always hope) to duplicate this success.

Paris Hilton was taken, Britney Spears is in rehab and Anna Nicole ...

K-Swiss just announced a poor outlook for 2007 and the stock dropped 13% today. I know this - of course - because I have owned k-Swiss for almost a year now. I was just about to decide if I should sell them or keep them - the stock is still on the list.

I think they made the decision for me. I don't care so much about the earnings - the poor 2007 outlook - all the cash they are hording - the financials - and all that stuff. It's really secondary to the decision to have

"Anna Kournikova As New Spokesperson for the Brand" .

I am sports guy and I understand that big time athletes promote brands - but what message are you providing with having Anna Kournikova as your spokesperson. Let's see:
- Looks are more important than winning
- I could be top 10 tennis player, but I am rather a top 10 bimbo
- Hard work is overrated
- Paris Hilton was taken, Britney Spears is in rehab and Anna Nicole ...
- Who cares about the quality of the shoe, as long as it looks good

What are they thinking ???

Batman, Robin and Joel Greenblatt II

All superhero movies have a sequel - so why not this post ? Although I am not sure I can go as far as the Batman sequels - they must be at number 5 or 6 by now.

Somebody pointed out on the Yahoo Magic Formula group that the Gotham fund only represents their stock investments and we do not really know about their other investments - which is a good point. But Greenblatt is famous for focusing on 5-8 stocks in the portfolio and I believe the historical returns of his funds are based just on these stocks funds. They had about 6 stocks a year ago -but now it's just those 2. And on top of that -- options - (sorry I just can't get over that)

You must have the following convictions for doing this:
- total faith in the overall market not having an adjustment >> even a 10-15% adjustment could wipe out the total investment - so there must be very little concern about that happening.

- believe in these stocks to really gain fairly quickly >> I guess one could sell the options and buy new ones - but the turnaround cost are pretty high and with this type of volume it can't be that easy to make buy and sell decisions. So no 2-3 year window here ..

- believe the stocks really take off >> again, these are option investments - the volume can be a big problem. A 30% gain may mean very little if you can't sell and turn into a much smaller return. I am not an expert on options - but I see my gains not fully materialize on good days and the volume is soooo low.

Batman, Robin and Joel Greenblatt

I know this was talked about before, but I always like to track and see what investments our dear author Joel Greenblatt has his money invested in. You can check the SEC filings for Gotham Capital - but it trails by 6 weeks.

Right away - you have to like the name - Gotham Capital. Not sure what his reason was for the name was, but I always think of Batman. And since we are investing according to his theory, that makes us Robin.

There are a couple of funds listed under the name and I am going to spare you the details - but the core investments boil down to 2 stocks. That fact alone is quite unbelievable - they have all their money invested in only 2 stocks !!!! Even if it is not your own money - or maybe that makes it even more gutsy - you have to have a lot of conviction to limit your investments to 2 stocks. So much for spreading your portfolio and limiting your risk.

The companies are Wal-Mart and American Express -- that does not sound so exciting. I thought Batman was a superhero and he would pull out some crazy company that builds "batmobiles" or something like that ??

If you look further - you see that they mostly bought call options for both companies -- OPTIONS !! Options ???? They must be really convinced - on the other hand - how can you return some 40% by buying regular shares of Walmart. Well was enough info for me to take a closer look -- I tracked to see the timing of the purchases by checking the quarterly statements and then I checked the price levels of both stocks in that time period. I did this for both - but for some reason I concentrated on Wal-Mart and only remember the numbers for them. The options were bought in Q1 of 2006 - the stock was in the 44 - 46 range and they bought A LOT OF THEM. I am actually not certain about the value of the options they have to report to the SEC. It seems that they have to report the number of underlying shares and the value of the shares - but not the actual value of the options. Which actually means that although the listed investment value of the fund is over a $1 billion - the actual market value may be much lower -- please somebody correct me on this one.
Keeping going - it's not easy to buy that many options even for a stock like Wal-Mart. They have options for about 15 million shares -- meaning about 150,000 options contracts. I think looking at the volume of Wal-Mart options and the outstanding contracts it's easy to assume that a large number of these options (probably all) are Jan 2008 $40 calls.
Well - since I invested so much money in the MFI stocks - I thought I might as well follow this one as well and I bought 5 of the Jan 08 $40 contracts about 4 months ago. Sure enough - after slight gains for the the first 3 month, Walmart just announced good earnings and went up 3.6%. That is of course a small gain compared to many other companies - but in world of options, you always have to use the great multiplier - in this case it's about 4-5.
Looks like Batman is still may favourite superhero - although it's a lot easier to write about a success than admitting a failure.

And I thought this was getting easier !!

Along the lines of the "Less is More" posting - I just realized that I am going to have some serious issues in picking my next round of stocks. I had bought 20 back in Feb 06 - so I am going to have to replace at least 15 over the next few weeks. The problem is that I either own or have researched about 45 out of the 50 stocks on the top 50 list. What to do now ???

I don't like buying any of the stocks that still show earnings 3 month behind or more)- that usually takes 10-15 out right away. Then I throw out any total nightmares - just don't have the stomach for some of the filing violations and delistings. By the time I take out the stocks I already own and the one's I did not previously buy for whatever reason, I am left with about 5 stocks. I need to buy 15 !!!!! Now, I guess I am going to have to increase my list to the top 100 MFI screen. But would you not rather have top 50 compared to top 100 -- and did the book not tell us that the stocks to perform in order ??

So many questions - and I thought after one year, I would have an easy way to pick stocks.

Magic Formula Investing results

Here is a look at my portfolios monthly returns:
- started with 20 stocks and then added about 6-7 every quarter
- now at 36 stocks; started selling 2 no gainers (close to 1 yr)
- 5 stocks were sold early for various reasons (3 buyouts / 1 tax and1 I just did not like)

MonthlyReturn of Total Return / Personal Return / Index Return

Mar 7.01 7.35 4.88
Apr 3.7 3.7 1.4
May -9.22 -9.82 -6.06
Jun 4.13 4.13 1.38
Jul -2.16 -2.16 -2.85
Aug 4.18 4.29 3.13
Sep -0.9 -0.9 0.74
Oct 4.61 6.2 6.04
Nov 3.76 3.57 2.5
Dec 1.2 1.2 -0.24
Jan 1.34 1.34 1.91
Feb 4.69 4.65 2.1

I used the Morningstar Small Core Index as a comparison. The TotalReturn is what Mutual Funds would use to list their returns (and anindex comparison) -- Personal Return includes cash in and outflows(you can see that during the month of the purchases -May / Aug / Nov -the personal and total return vary because of cash in and outflow)
Trends:
1) Overall I am doing great: + 28% total return // +25% personalreturn VS the index of 15% (SP500 would be about the same).

2) The May numbers serve as a cautious reminder that in a downturn,the portfolio may take a big beating -- market was down 6% vsportfolio at -9.8% - which is also the biggest monthly difference(positive or negative) of any month.

3) Transaction cost -- Even at 43 stocks the transaction costs arerelatively low -- 43x$6 ($3 per trade)= $258 or about 1/4% of value

4) Tough to track dividends - I use Morningstar and they recorddividends by reinvesting the $$ into the shares - I wish it was thateasy. The money usually just sits there for a couple of month until Ican invest it into new buys. It comes down to just being a little tolazy to make my own spreadsheet analysis - but I just add about 1%and don't get obsessed about it.

Less is more !!!

After one year of MFI I have come to the conclusion that "less is more" in terms of analysis of the stocks I buy and own. Well, not 100% less (or complete faith) - meaning no self research, but anything more than 5 minutes per stock is not a good idea for myself.
There is always a reason that a stock is on the MFI list -- earnings hike is just a one-time thing; future earnings outlook is dreadful because industry in total decline (check business - forgot the name - did not buy the stock); oil field is somewhere in Africa and political problems (EGY); copper prices are only up temporarily (FCX); all business is with one customer who may choose to take a hike (my nightmare with Portalplayer) -- there is always a reason and you should be able to see the reason within 5 minutes. Usually there is a break in the chart and all you have to do is check for the news around that time.
Once I am past the 5 minute mark and especially if I don't see the obvious reason - I am in trouble, because I start "liking" the stock more than I should. I just could not understand why Portalplayer was on the list with being part of the most successful consumer product this decade (IPOD) -- so I bought more stock "outside" of my MFI portfolio - BIG mistake.
The almost made the same mistake with Grubb-Ellis - the commercial real estate company - I can't figure out why the stock is so low. There are buy-outs in the industry - the stock is valued very low and Grubb-Ellis has a good name. I can't quite figure out the ownership situation and classes of stocks they have sold - which I think is the reason the stock is not doing very well. But I went beyond my 5 minutes and spent a lot of time on this and it is just not very useful.
Blind faith - or picking at total random has not worked either. I picked my May portfolio of 7 stocks at random and they are not doing so well (about 2% gain vs 15 for indexes). There were 2 stocks in particular, I almost knew would be dogs right after I bought them - National Dentex and Toptanker.
So in the future, I am going to stick to the 5 minute rule and finding the reason, each stock is on the MFI - but that's just for me.