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Magic Thoughts



March 29, 2007 – Comments (5)

I read the book Magic Formula Investing. I was not impressed.

Mr. Greenblatt, the author, says buy the thirty stocks with the highest ROIC (100%), hold them for one year and then sell them. This process is repeated year after year. While not specifically stated, I guess the investment return to the person following this stragey is very good.

I never understood why Mr. Greenblatt was trying to sell a book when he has THE formula that should be making him wealthy beyond description?

I also don't quite grasp the need to sell after one year. According to Mr. Greenblatt, one year was chosen because the ROIC formula works with trailing twelve month tax returns.

I guess the part that didn't make sense to me was sell first and then reassess. Why? According to Mr. Greenblatt, it takes 3-5 years for the "formula" to work, so why not hold the stocks, reassess, and go from there?

I've always wondered if a person bought a stock, not a stock of the day but just a stock, and paid no attention to the stock's price or value, if the price of that stock would go up any significant degree over a 3-5 year period? I have a feeling it probably would.

Wow! Could that be a new investing strategy? Just pick a stock, any stock other than one constantly in the news, then buy that stock and hold it for 3-5 years, five years being preferable to three.

After three to five years, sell half and hold those shares for 3-5 years, and then sell half again. And so forth and so on until all the shares are gone.

I wonder what the return would be with that strategy over the course of an investing lifetime?

Just think, if a person were to actually use such a strategy and couple it with using a margin of safety for the stock purchase they might just do okay...over the longer term that is. Hmmmmm.

At the end of the day, I personally believe the only Magic Formula that will consistently provide an investor with returns that far outweigh the risk taken, is buying with a margin of safety.

Something I don't see Mr. Greenblatt's formula doing.



5 Comments – Post Your Own

#1) On March 29, 2007 at 8:57 PM, degaston (< 20) wrote:

What do you mean by MARGIN OF SAFETY? For buying? And for selling? At what point do you say it's a good enough value to buy? At what point do you say it's no longer a good enough value to keep owning?  I'm just curious to know your thoughts on this.

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#2) On March 29, 2007 at 10:37 PM, degaston (< 20) wrote:

I hope you don't mind some questions. Do you still stand by your reasonable value estimates? Do you think GGC could be reasonably $64? NL $30-32? KND $82-87? I frankly find your analyses to be quite interesting. I'm just wondering if your present analyses of these 3 firms is still consistent with your past analyses.


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#3) On March 30, 2007 at 7:14 AM, wax (< 20) wrote:


First things first I suppose, which would be the margin of safety.

In my piece Parts Lessons,  I talked about a margin of safety as well as some of the other things I do to manage my portfolio.

Ben Graham was the person that developed the margin of safety strategy when BUYING a stock, back in the 1930s. It works like this.

Determine what YOU think is a reasonable value for a stock using whatever means YOU are comfortable with, and then divide by 2.

The result is your buy target, the point at which you want to start a position in a stock.

I recommend that you follow the link above and read Parts Lessons, as it should answer the remainder of you questions.

If you have more, feel free to ask anytime. I ask that you please remember that what I do works for me, and may not work for someone else.

As to the second comment, yes I believe that my reasonbable value estimates are still valid.

Bear in mind however that the estimated values I placed on these stocks was for a 3-5 year hold, and along the way I would not be bashful about adding shares if the price becomes favorable.

The other thing you need to know is that I actually do own shares of Georgia Gulf Corporation (NYSE: GGC) and NL Industries, Inc. (NYSE: NL), and have been adding to my positions on recent price pullbacks.

The other thing you need to know is that barring some sort of emergency, I have no need of the money I have invested for at least the next 15 years.

So even if I have miscalculated in my valuation, instead of 3-5 years to reach my target value, I have 15 years.

Hope this helps.





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#4) On March 30, 2007 at 5:00 PM, degaston (< 20) wrote:

Thanks for your insights.  Since your estimates make GGC seem like a potential 4-bagger in the next 3-5 years based on its present price I did some more in-depth research on this stock myself. 

They've had a drop from $58.75 in December 2004 to the present $16+. But they've continued to gain return on capital traction without costs of capital going up. They still pay their $0.08 quarterly dividends. Their long-term growth prospects are still solid. Their management team are all seasoned professionals in their early 50s with good incentives to keep them focused on GGC's stockholders best interests.

Their price is low now for the following reasons:

(1) Long-term weakness in the chemicals industry. It's cyclical and will have its up cycles. When it's in up-cycle we'll see the retail investers jump in. With only 532 stockholders as of Feb 2006 this stock has "retails don't know about it" written all over it.   

(2) The housing industry is quite weak right now and likely won't be recovering until at least 2009-2010. But it will recover. And with the good access to resources domestically, GGC will be well-positioned to charge ahead on a global scale.  

(3) The delays of their 10K filing due to the merger with Royal have created uncertainty. Once the numbers from the Royal deal are assimilated into GGC's outlook we'll see how it's helping them improve their business. That should help the stock rebound 10-30%.  

I'm predicting $2.50 per share net earnings in 2008 (i.e. $85 million) on $2.2 billion in revenues. with an average 10-15% revenues growth and 15-20% earnings growth annually afterwards for the next 3-5 years. That's why this company should have a market cap of $2 billion. But its present market cap is less than a third. So I bought some.   


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#5) On March 31, 2007 at 5:53 AM, wax (< 20) wrote:


I hope you do well with this stock over the slightly longer term. Your reasoning appears to be sound, so I hope all works out.

As to growth, earnings or revenue...never touch the stuff. Growth is something that's hoped for, something that analysts have sold the common investor for years and years.

When you take growth out of the mix, what you end up with is something closer to fair value. Then if you get some growth...well it certainly is cool when that happens.

Anyway, thanx for the thoughts!




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