Weekly roundup of stocks moving in and out of the Magic Formula Investing screen. [more]
An interesting aspect of Joel Greenblatt's Magic Formula Investing (MFI) strategy is that its precepts can be applied to a variety of other stock strategies and focuses, as well. For example, if you like to invest in small caps, MFI can be used to find some good, undervalued businesses in a sector that is under-followed by professional equity analysts (here is an example). If you are looking to invest in foreign markets, MFI can be applied to stocks in foreign exchanges, and so forth.
We can also go the other way, and apply additional criteria to stocks in the official MFI universe. In theory, doing this starts with a list of good, undervalued companies, weeding out a lot of junk from the beginning. This article will focus on combing through the 3 screens covered by MagicDiligence (top 50 over 50 million and 1 billion, top 30 over 3 billion), looking for MFI stocks that may interest those who follow a long-term dividend-focused investing strategy. [more]
Reynolds American (RAI) is one of the largest cigarette and tobacco products manufacturers in North America, trailing only Altria Group (MO - formerly Philip Morris). RAI commands about 28% of the U.S. tobacco market vs. Altria's 50% share. The company has a wide array of cigarette brands covering every general category such as premium (Camel, Winston), branded menthol (Kool), and discount (Pall Mall, Doral). In 2006, the company acquired Conwood, the second largest manufacturer of smokeless tobacco products, for $3.5 billion, adding popular brands such as Grizzly and Kodiak. Reynolds also runs the Santa Fe Natural Tobacco subsidiary, which produces the American Spirit brand of additive-free cigarettes. The current company was formed in 2004 when R.J. Reynolds merged with Brown & Williamson, the U.S. arm of British American Tobacco (BTI).
Tobacco stocks are a much-maligned group that have nevertheless delivered outstanding long-term returns to shareholders. Wharton professor Jeremy Siegel, in his book The Future for Investors (MagicDiligence review), showed how Philip Morris was by far the best original S&P 500 stock, returning an amazing 19% annually to shareholders over a 50 year period! This is due mainly to the effects of compounding reinvested dividends, especially when combined with the inherent volatility in the share price. When the share price goes down, the dividend yield goes up, and investors that reinvested Philip Morris' substantial and always rising (42 consecutive years) dividend were rewarded handsomely. [more]
This week's turnover in our three Magic Formula Investing screens: [more]
One of the most common questions received here at MagicDiligence is "how many stocks should comprise my portfolio?". This may, in fact, be one of the most common questions that individual investors around the world ask. Let's take a look at the reasons behind diversifying stock positions, investigate the answers and actions of some well-known investors, and then see what the Magic Formula Investing strategy has to say about the topic. In the process, hopefully we can come to a conclusion on a good number of stock positions to be sufficiently diversified (without over-doing it).
So, first, why diversify at all? The simple answer is to reduce risk. In investing, there are two basic categories of risk, which we will call "macro risk" and "micro risk". Macro risk are systematic concerns that can affect all stocks negatively. Examples of this would be recessions, military conflicts, inflation, high interest rates, and so forth. Micro risk, on the other hand, applies only to a single company or a number of related companies. For example, the FDA's loss-of-smell warning on Matrixx Initiatives' (MTXX) Zicam nasal products caused that stock to plummet 75%, but did not really affect any other stocks. These micro risks can also affect a handful of players in a particular industry or geographic area. [more]
Terra Industries (TRA) is a producer of nitrogen-based fertilizer products. The company is one of the largest North American-based producers, competing with CF Industries (CF) and Agrium (AGU).
Terra has been embroiled in a three-way takeover triangle over the past year with these two competitors. Last January, CF made a bid of about $20/share for Terra, which was immediately rejected. CF then took the bid hostile, nominating three directors for election to Terra's board. Meanwhile, in February of 2009, Agrium made a takeover offer to CF (at about $72/share), then took its own bid hostile by opening a tender offer for CF shareholders! This is important to Terra, as Agrium's offer is contingent on CF dropping their bid for Terra. Both of the hostile bidders achieved some victories, with CF getting its directors elected to Terra's board and Agrium achieving about a 63% subscription to their tender. However, neither offer has been closed. [more]
This week's turnover in our three Magic Formula Investing screens: [more]
MagicDiligence is dedicated to researching and recommending the most fundamentally attractive stocks in Joel Greenblatt's Magic Formula Investing (MFI) screen. But what exactly is this Magic Formula Investing strategy? How does it work? More importantly, does it work?! In this article, we'll briefly go over the strategy's philosophies, implementation, and past results. Anyone interested should pick up a copy of Greenblatt's book The Little Book that Beats the Market. It is the "bible" of MFI.
The philosophy behind the strategy is very simple and straightforward: buy great companies at cheap prices. That's it. It does not focus on particular industry sectors, does not concern itself with how big or small a company is, completely ignores forward earnings estimates, and does not discriminate between dividend payers and non-payers. [more]
Cardinal Health (CAH) is a pharmaceutical distributor, acting as the middleman between drug manufacturers and consumer delivery firms, such as retail pharmacies and pharmacy benefit managers (PBMs). Cardinal provides the benefits of consolidated purchasing power, warehousing, repackaging of drugs, procurement, and so forth. The firm is now a pure play on drug distribution, having completed the spin-off of their medical products division into CareFusion (CFN) back in September.
MagicDiligence has written a few pieces before on the drug distribution business, comparing the three major players against each other and also taking an in-depth look at competitor McKeeson (MCK). The industry has some attractive qualities. It is largely recession proof, as medications often are critical in extending the quality or duration of life. It also has very high barriers to entry. With operating margins barely over 1.5%, scale is critical to being sufficiently profitable, given the high amount of fixed costs required. It is unlikely that a new competitor would be interested in putting forth the capital and time required to build the necessary scale, given the margins involved. This will likely leave the market to the three current players: Cardinal, McKeeson, and AmerisourceBergen (ABC). With this comfortable oligarchy, irrational pricing is another competitive risk we can largely eliminate. [more]
Vector Group is structured as a holding company, but the company's business is selling discount cigarette brands in the United States. Their two largest brands are Grand Prix (29% of volume) and Liggett Select (23%), and the company also sells Pyramid, Eve, and USA. Vector Group also owns a 50% stake in Douglas Elliman, a realtor in the New York metropolitan area, but real estate is such a small contributor to operating earnings that it can basically be ignored for the purposes of analysis here.
There are few bullish arguments on the stock, but let's address them anyway. First, Vector occupies probably the most attractive niche of the cigarette business: the discount end. Discount cigarettes have been about the only sector of this market to experience volume growth in the last decade, as premium brands are being priced out of the range of lower income smokers. Also, the 1998 litigation settlements with 46 states require only the 3 largest cigarette makers to pay the costs. Vector's Liggett Group is 5th, and as a byproduct has gained a valuable cost advantage against bigger makers like Altria (MO) and RJ Reynolds (RAI). The "big boys" are handcuffed by these costs if they decide to compete in the deep discount cigarette market, a significant competitive advantage for Vector Group. [more]
What a difference a year makes! In 2008, the S&P 500 had its worst year in the history of the index, plummeting nearly 40%. I said in the 2008 year in review that those that had the intestinal fortitude to hold equities through that bloodbath would be handsomely rewarded over the next few years. It turned out that it only took one year to see some nice gains. SPY, the S&P 500 ETF, appreciated over 26% in 2009. Right now, many equity analysts are fretting about the index being at historically high price-to-earnings multiples, but we must remember that those multiples are against depressed earnings in 2009. As the economy recovers, the earnings part of the multiple should rise, and prices should follow suit. MagicDiligence still believes there is upside in stock prices from current levels.
2009 was a great year for Joel Greenblatt's Magic Formula Investing (detailed in his book, The Little Book that Beats the Market). MagicDiligence uses three Magic Formula screens: the top 50 stocks over 50 million market cap, top 50 over 1 billion, and top 30 over 3 billion. However, for the first few months of the year the "old" top 100 over 50 million and top 50 over 2 billion screens were used. As a result, I've included just the 50 million screen and the 2-3 billion screens as "small" and "large" cap. Below is a table that shows the results of buying the entire Magic Formula screens once each month this year, and their aggregate performance against the S&P 500 (created using the Magic Formula Historical Performance Tool): [more]
Weekly roundup of stocks moving in and out of Joel Greenblatt's Magic Formula Investing screen. [more]