Pre-Paid Legal (PPD) offers what amounts to "legal insurance", where customers purchase a membership subscription and in return receive legal coverage for such incidents as traffic violations, trial defense, will preparation, identify theft, and so forth. Memberships are mainly sold to middle income individuals or families, and monthly fees range from about $15-25, with some products, such as the identity theft shield, extra. The company contracts with small legal firms around the U.S. and Canada, usually driving the bulk of business for these firms through customer referrals. This makes the relationships pretty solid, with most of the firms with PPD for over 8 years. Pre-Paid Legal pays these firms a monthly fixed fee that does not change based on the benefits realized by subscribers. This fact eliminates nearly all claims risk that most insurance companies face, making Pre-Paid less of an insurance provider and more of a referral company.
Let's address the positives first. Financially, Pre-Paid Legal's business model is an attractive one. Capital requirements are low for this kind of product, which allows the company to put up nice MFI return on capital (108%) and free cash flow (14% free cash margin) numbers. Management has been generous with this free cash flow, returning it to shareholders by aggressively repurchasing shares over the past 5 years. Shares outstanding have declined at a 6.7% per year clip in that period. Competitively, there are virtually no prepaid legal plan providers that target individual families. Nearly all competitors focus on larger employer groups, creating a nice niche for Pre-Paid to operate in. The company's marketing structure is very low cost and scales up and down naturally with the number of subscriptions sold. [more]
At its core, Joel Greenblatt's Magic Formula Investing (MFI) strategy is a value-based, mechanically driven stock picking strategy. A key to success with MFI is not to filter out small-cap stocks from it. In fact, including stocks with a minimum market cap of $50 million far outperformed limiting your investment to stocks with at least a $1 billion market cap. The difference was amazing. With the small-caps, MFI returned over 30% annually over a 17-year period, while without them, the return was much lower (but still good) at a about 20% a year! Here are 5 reasons why small cap, value investing should be a part of every portfolio, Magic Formula or otherwise: [more]
This week's turnover in our three Magic Formula Investing screens: [more]
Joseph Piotroski is an former accounting professor at the University of Chicago, and an active value-based investor. He noticed when reviewing stocks with very low price-to-book value that many of them were in poor financial shape, unlikely to survive and deserving of their low valuation. Piotroski set out to devise a system to take these low price-to-book stock lists and mechanically filter out the ones that were unlikely to survive and prosper, leaving a number of potentially attractive investment opportunities.
Piotroski's method is very simple. A stock is scored by 9 different, and very simple, criteria that measure the company's performance between the past 2 years. The stock gets a '1' for each test it passes, and a '0' for each test it does not. If both years show identical values, a '0.5' can be awarded. At the end, all of the scores are added up to come up with the Piotroski score. In this scale, a '9' is a perfect score, passing all tests. '8' (and '8.5') are excellent scores worthy of consideration. Back-testing has found that choosing stocks with low valuations and Piotroski scores of 8 or 9 vastly outperforms the market. [more]
Endo Pharmaceuticals (ENDP) is a specialty drug company, with a focus on a few specific areas, namely pain management, urology, and endocrinology. Pain management is the company's forte, led by Lidoderm, a lidocaine medicated patch that is prescribed for a wide variety of pain-related problems. Lidoderm gained traction after orally ingested pain killers such as Vioxx (MRK) faced well-publicized safety concerns in the mid-2000's. Today, Lidoderm accounts for well over 50% of Endo's total sales, bringing in $763 million dollars last year.
Another 16% of sales is generated by the Opana franchise. Opana is orally ingested and is used to treat severe pain symptoms. It is used much like morphine. The third major drug marketed by Endo is Percocet, the well-known painkiller for less severe pain indications. Percocet accounts for about 9% of Endo's total. [more]
What we know for certain about the screening criteria at the official Magic Formula site is detailed in The Little Book that Beats the Market and on the site itself. The appendix in particular of Joel Greenblatt's book provides some details as to how both earnings yield and return on capital are calculated. Many (including MagicDiligence) have tried to recreate the statistics to meet those from the screen, and in general have gotten pretty close. But the exact formulas remain, like Coca-Cola (KO), a well-kept secret (the "new" official site doesn't even list them anymore).
This has led to some questions as to why certain stocks that certainly appear to have Magic Formula statistics don't appear on the screen. Using an alternative MFI screen at Magic Formula Investing EU, I've dug up and verified 3 interesting micro-cap stocks that seem to have MFI-worthy statistics yet do not appear on any of the official screens. They might be worth some additional research by both MFI and value investors in general. [more]
Unisys (UIS) is a technology products and services provider. The company operates through two units, which are simply called services and technology. Services is by far the largest unit at over 80% of revenue. This group is further broken down into information technology outsourcing (ITO, 70% of the segment), and business process outsourcing (BPO). ITO consists of things such as systems integration, consulting, and management of customer's IT infrastructure. BPO is when customers outsource a particular function, such as payment processing or cargo management, to Unisys. Most of the company's clients here are in financial services.
The technology group is product-oriented, marketing and selling ClearPath enterprise servers along with related operating system and middle-layer software. While this was traditionally Unisys' bread-and-butter, it now represents under 20% of sales and will continue to decline going forward. The bulk of legacy clients for technology products are in the public (government) sector. [more]
In last week's review of Morningstar's MFI article, the article's author referenced a pamphlet from investment company Tweedy Browne titled "What Has Worked In Investing" (download it here). MagicDiligence took a look at the pamphlet and there were some interesting results referenced in there that may be of interest to Magic Formula investors, as the MFI strategy adheres very closely to some of the mechanical methods referenced within. In this article, I'll attempt to summarize the basic conclusions provided in the pamphlet and add some of my own thoughts as well.
At the very beginning, Tweedy mentions 5 mechanical (statistical) criteria that they believe identify stocks that may present investment potential beyond the returns of the general market. These 5 criteria are: [more]
Lockheed Martin (LMT) is the largest defense contractor in the world by sales. 85% of sales originate from the U.S. federal government, particularly the Department of Defense (DoD). Another 13% comes from foreign partner governments, and only 2% come from the private sector. The current company was formed by the 1995 merger of Lockheed, historically a defense aerospace company, and Martin Marietta, who was known for their space systems.
The remnants of the mega-merger can be seen in Lockheed Martin's four operating segments. Aeronautics (27% of sales, 30% of profits) makes and maintains some of the well-known military jets and transport planes, such as the F-16, F-22, and C-130J. Lockheed has a long history making fighter and stealth jets, dating back to famous planes like the SR-71 Blackbird and F-117 Nighthawk. [more]
This week's turnover in our three Magic Formula Investing screens: [more]
Quidel (QDEL) is a maker of rapid medical diagnostic tests that are aimed at the point of care (POC). Basically, this means the test can be administered by a doctor, nurse, or other health-care worker and results can be received in a few minutes, compared to hours for the typical "send to the lab" method known as IVD (in-vitro diagnostic). Quidel markets tests in two primary segments under the QuickVue brand name - infectious disease (78% of sales) and reproductive/women's health (13%). Tests focus on things such as influenza, strep throat, RSV (an upper respiratory virus associated with children), pregnancy, Chlamydia, and various digestive tract problems. Quidel generates about 20% of sales outside of the United States, mainly in Japan.
The company expanded its business by about a third when it acquired Diagnostic Hybrids (DHI) earlier this year for $130 million in cash. DHI is a provider of specialized IVD testing for similar indications as Quidel's POC tests. Looking at DHI on a stand-alone basis, it was growing sales at about 25% per annum and expanding operating margins faster than that. Quidel's purchase price looks to be at a reasonable valuation (7.7% MFI earnings yield, about a 19.3 enterprise value/earnings ratio). [more]