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MagicDiligence (< 20)

The 5 Biggest Losers of Magic Formula Investing in 2013

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December 18, 2013 – Comments (0) | RELATED TICKERS: STRA , FABU , DXM

Earlier this week, we looked at the 5 best performing stocks of Magic Formula Investing (MFI) in 2013. Today, we'll flip the script and review the 5 worst performing stocks the strategy offered up in the past year. Again, all results here are from the "top 50 stocks over 50 million market cap" from the official screens.

Reviewing the strategy's biggest losers can be even more constructive than reviewing the winners. MFI has a pretty good "hit rate" - historically, the majority of stocks it screens go on to outperform the market. In 2013, that rate was really excellent, near 75%. But follow it long enough (MagicDiligence has for 6 years) and some patterns emerge as to stocks to avoid. Even just weeding out some of the bigger losers can dramatically improve overall returns. On the other hand, perhaps some of these stocks are oversold and make interesting investment candidates heading into 2014?

Worst Performing Stocks in 2013

Here are the 5 biggest losers and some lessons we may be able to take from them...

Metabolix (MBLX) - down 44% from Mar. 13

Metabolix's story sounds good. The company works on developing environmentally friendly plastics, chemicals, and bio-fuels. The problem is demand - there is none! Metabolix has posted a big quarterly loss in each of the past 6 quarters, and relies on grant money for a significant portion of revenues. The only way the firm ever appeared in MFI was due to a $39 million termination payment from Archer Daniels Midland (ADM) in the first quarter of 2012.

The Lesson: Metabolix is an example of one of the cardinal rules of choosing MFI stocks: avoid the one-time revenue effect! You see this frequently, with small companies that partner with larger ones getting a huge one-time injection of revenue that completely clouds the sustainability of the business. In this case, Metabolix has shown no signs that its business model is sustainable over the long term, even though the story is a good one.

Strayer University (STRA) - down 47% from Feb. 13

We saw how well for-profit education stocks Capella (CPLA) and ITT (ESI) did over the past year, andApollo Group (APOL) did good as well. Strayer has been the laggard, primarily because the firm has trailed its peer group in both experiencing the enrollment downturn and in rebounding from it. At this point, though, Strayer's 22.4% earnings yield is far higher than the rest of the group's, the company is taking aggressive action to re-ignite enrollment and cut costs, and financial health is still acceptable.

The Lesson: There has been a rolling wave of declines and rebounds in for-profit education, and Strayer seems to be at the end of the chain. We've already seen the stocks of its peers reach their nadir and start to climb, while Strayer continues to hover right at its multi-year lows. I don't see any particular reason the stock cannot follow the sector's rebound in 2014, although its tuition cuts and campus closures seem draconian.

Body Central (BODY) - down 55% from Feb. 19

Body Central is a mall-based apparel and accessories retailer, focusing on late teens/early twenties women. There is nothing really remarkable to say here other than this company is not performing well. Here are the same-store sales comparisons for the past 7 quarters: -18%, -13%, -10%, -12%, -12%, -12%, -8%! Meanwhile, the company inexplicably continues to add 25-35 new stores every quarter. As a result, the firm is now posting some big net losses. On the plus side, the balance sheet remains debt-free and any improvement in operations could trigger a large spike in the stock price.

The Lesson: Tread carefully in retail, particularly mall-based apparel. This is a highly competitive field and these stocks are volatile, often swinging plus or minus 20% in the span of weeks. Most importantly, in competitive industries, make sure management is top-notch. BODY clearly needs better leadership, the current group is not getting it done.

FAB Universal (FU) - down 63% from Nov. 15

Chinese reverse-merger stocks were a thorn in the side of MFI in 2009-10, severely hurting the strategy's performance as one after another was revealed to be a fraud and saw their stocks go to zero (anyone remember China Sky One Medical, Universal Travel, China Education Alliance, et. al.?). Well, the screen's filter still hasn't entirely eliminated them. FAB Universal showed up this past November and, sadly, is still listed on the official site, even though trading has been frozen since November 22. Astring of posts from "Alfred Little" on Seeking Alpha appears to have exposed yet another China-based ruse on U.S. investors.

The Lesson: Simple. Stay away from Chinese reverse mergers. Stay far away!

Dex Media (DXM) - down 71% from Jun. 6

When MagicDiligence launched, one of the reasons was to warn people away from stocks like Idearc, a yellow pages company with a plummeting business and an enormous load of debt. Idearc predictably went under, only to resurface as SuperMedia - the same pig with new lipstick. SuperMedia quickly fell from its IPO price of over $40 to sub-$5. Then, this past April, SuperMedia merged with Dex One, doubling down on a losing business model. Not surprisingly, soon after the merger, Dex Media's stock swan dived into the abyss. The company still has a huge $2.7 billion debt burden and has generated a net loss in each of the past 2 quarters.

The Lesson: Idearc/SuperMedia/Dex Media has been the biggest recurring loser for the MFI strategy. Staying away from the stocks of rapidly declining firms with horrifying balance sheets - regardless of price - is always good policy for avoiding the risk of losing all or almost all of your investment.

 

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