Many MagicDiligence readers are probably familiar with The Motley Fool's CAPS service, and for those of you who are not, I highly recommend checking it out. In essence, CAPS is the world's largest free stock picking game. More than 170,000 individual investors have rated more than 5,600 stocks. Every player can rate any stock to outperform or underperform the market, for a variety of time periods from "a few months" to "5 years or more". The rating is then assigned a beginning stock price, and the percentage change in the stock price is tracked vs. the change in S&P 500 (including dividends). Picks outperforming the S&P 500 get a positive score, and under-performers get a negative score. Then all players are assigned a rating based on a number of factors, including total overall score, pick accuracy, and so forth. The player score is between 0-100, and the higher the better. [more]
Magic Formula Investing (MFI), as described by hedge fund manager Joel Greenblatt in The Little Book that Beats the Market, consists of ranking stocks by earnings yield (cheap) and return on capital (quality), adding the rankings together, and buying from the resulting lists. Below are stocks that have moved into, and dropped out of, 3 of the MFI screens used by MagicDiligence: [more]
It is one of the fundamental facts of Joel Greenblatt's Magic Formula Investing (MFI) screening methodology: small research pharmaceutical firms almost always show up shortly after receiving one-time windfalls such as hitting development milestones or receiving collaboration payments of some sort. These huge shots of revenue spike profits, causing trailing 12 month returns on capital to skyrocket. At the same time, human investors realize that these payments are non-recurring, keeping the stock price at a reasonable level but creating what looks like a very low valuation (low P/E ratios, or high earnings yields). Bingo, the perfect formula for getting screened by MFI! I believe it is one of the side effects of the simple screening methodology, and it breaks the strategy's core mission of finding "great companies selling at cheap prices".
It is not just an annoyance, either - a significant number of these stocks constitute the current small-cap (top 50 over $50 million) screen. Currently, 8 of the 50 stocks can be classified as small research pharmaceutical firms - a meaningful 16%. Some have approved products that pay royalties, some do not. Some have multiple late-stage drug candidates, some do not have a pipeline past Phase II. One thing they all have in common is that it is extremely difficult to value them due to the inherent uncertainties in drug development. MagicDiligence generally recommends taking a "basket approach" if you want exposure to these names - buy a little of each of them instead of dedicating a full portfolio position to one in particular. [more]
The Magic Formula Investing (MFI) strategy is simply a ranking system. Any particular universe of stocks can be ranked in the strategy's fashion - a composite of highest earnings yield and highest adjusted return on capital, both factors equally weighted. You can apply the strategy to rank any "basket" of stocks, ranging from entire exchange listings (or groups of exchange listings), to a pre-screened list of stocks, and so forth. The possibilities are limitless.
The official MFI site allows users to rank all U.S.-listed stocks, separated only by minimum market cap. So, for example, choosing the top 50 stocks with a minimum of $100 million market cap will produce a much different list than choosing the top 50 with a minimum $1 billion market cap. This is useful, as many investors are uncomfortable buying issues of thinly traded, micro-cap stocks that they may not familiar with (even though small-caps, historically, have drastically improved performance). [more]
For those who have ever wandered into a Target (TGT) to buy new clothes or shoes, encountering the Cherokee (CHKE) brand is inevitable. What you may not know is that this remarkable little company has only a handful of full time employees, less owned property then many small families, and yet collected over $30 million dollars in revenue last year and turned 40% of those revenues into free cash for its stockholders! Clearly this is one remarkable business - and according to the Magic Formula its stock is also on sale. Let's take a look at this intriguing little ($160 million) company.
First, the business. Cherokee is strictly a brand licensor. It owns the Cherokee, Sideout, and Carole Little brands (among others), which it licenses to selected retailers. The company does no product design, no production sourcing, and little marketing - this is left to the licensees. Cherokee provides and fosters well-known brands that allow customers to charge more for what is, in effect, store-brand merchandise. This is what's known as a "light" business model, requiring next to no capital investment and few expenses save for paying the handful of employees and maintaining the brand trademarks in various countries. As a result, Cherokee is a phenomenally efficient business, with post-tax returns on capital routinely climbing above 150%. [more]
Note to CAPS readers: CAPS does not handle tables very well. To see a properly formatted version of this post, please see the original article. [more]