PWEI RIP

One of my holdings, PW Eagle (PWEI), was bought out today by a private company PW Eagle says $400 Million Buyout is Complete. Ended up with a slight loss, which was ok since it was a slightly greater loss the whole time I owned it.

TRLG jumped 10% today as a result of an analyst's change in recommendation. Technically, nothing changed about the company today that I'm aware of. It's "Mr. Market" in action. This increase slightly offset an overall general decline today. My net decline for the day was equivalent to the S&P 500's decline of .32% (I don't EVER get worked up about market declines in points. ONLY percentage. I remember when the market dipped in February the headlines screaming that it was one of the largest declines ever...in dollars. In percent, there was a similar decline on average every year. Naturally, after this, the market had a powerful run up which is now losing considerable steam.

I think Joel Greenblatt is right. Even having revealed that this system works, no one needs to worry about everyone adopting it. Most people are just too irrational about it and undisciplined.

Steady as she goes...

HNR has settled down a bit, but is still at a handsome gain of 19.46% right now. The best part about it, is that it brought up a "lagging" tranche. I've been comparing each batch of 5 stocks purchased every two months against a comparable purchase of VFINX, Vanguard's S&P 500 index (with all distributions reinvested). Here's where they all stand:

Purchase date, MFI gain, VFINX gain

3/06, 28.80%, 11.04% (CLOSED)
5/06, 27.01%, 14.80% (CLOSED)
7/06, 14.97%, 21.81% (OPEN - all following are still open)
9/06, 49.17%, 19.24%
11/06, 13.33%, 11.33%
1/07, 11.12%, 8.56%
3/07, 1.57%, 9.86%
5/07, 8.77%, 1.11%

Overall average (weighted):
MFI 18.04%, VFINX 11.60%

I'm very happy that of all of these, only two tranches lagged the market, and with no overall loss in any tranche. Plus, 3/07 is really too soon to see where it will end up. Naturally, several of the results were due to one or two "outliers" within the tranche. Examples:

3/06 PNCL 145% gain and AEO 50% gain, offset by FORD 54% loss
5/06 VPHM 59% gain, MVL 44% gain, KMG (Kerr McGee, no longer listed) 36% gain, offset by a loss on FDG of 23%
7/06 KFY up 35%, IVII 28% gain (no longer listed), offset by ORCT down 13%
9/06 WNR up 154%, FTO up 50%
11/06 FCX up 39%, CRYP up 36%, offset by CLHI down 32%
1/07 HNR up 19%, OVTI up 23%, TRLG up 24%, offset by PWEI down 3% and RAIL down 9%
3/07 LRW up 27% offset by OPTI down 24%
5/07 FDG up 20%, JAKK up 14% (I lost 7% on JAKK in the 3/06 tranche)

FORD by far my biggest stinker, PNCL and WNR by far my biggest winners.

Is being random gambling?

It's funny, on MG's blog http://justadrone.blogspot.com (highly recommended reading), Travis commented that "flipping a coin" (in this case, my use of random.org) seemed too much like gambling. I respect that view, and it's not unlike comments made by a very good friend of mine, ever since I first started discussing MFI and my methodology with him. In fact, whenever I tell him about a stock movement in my MFI portfolio, we refer to it as my "dartboard" stocks.

But, am I in fact gambling? Perhaps. Much less so, I would venture, than someone in Vegas or someone buying a lottery ticket. In fact, significantly less so, I believe. Let's think about it.

I re-read The Little Book that Beats the Market recently for some insight. Let's start with this tidbit. If I select one of 25 stocks from the MFI website, I am picking the top 25 stocks over a certain threshold (in my case, I use the minimum, $50M) based on the MFI criteria. Now, I don't consider the MFI criteria to be a gambling method. I think it's very sound reasoning. Well run companies trading cheaply. Basic value investing.

So, when you have these 25 stocks, that's 25 stocks out of a universe of 3,500 stocks. You are now in the top 0.7% of the MFI stock universe. Consider it to be the inverse of the concept that buying 2 lottery tickets doesn't remotely improve your odds of winning. The difference between any of the top 25 stocks in the MFI universe is minute (at least from a percentile perspective).

However, within those 25, there will be winners and there will be losers. Hence the need for diversification. I'll be interested to see the result of Tony's study http://magicformulainvestor.blogspot.com to get an idea of the ratio. Because I do not have the time or inclination to research individual stocks sufficiently to do better than a "dartboard" approach, I actually think it is more likely than not that my conscious picks will lean towards the losers! I think I'd be gambling more if I tried to pick them myself!

Instead, by utilizing a random method, I am investing with the MFI methodology in an unbiased manner.

The other thing I am doing that I think will make a difference (though only time will tell) is following the methodology rather strictly. Buy and hold for a year. Buying at even intervals through the year. And I am absolutely not trying to time the market. If I really had the ability to time the market, I'd be a wealthy, and probably famous man. I am neither. Don't care about the latter, but working on the former. :)

-A

Harvest Natural Resources

Wow! Here's another example of why it's better not to let me think about things. When it came time to pick my mfi stocks in January, one of the stocks that was randomly picked was Harvest Natural Resources (HNR). Now, when my stocks are picked, I do take a look to see what they are. When I saw that most of their revenue comes from managing oil and gas fields in Venezuela, I immediately didn't want to buy them. I've followed Venezuela's descent into communism and totalitarianism under Hugo Chavez very closely and have been disgusted by the outright theft that Chavez has been perpetrating in the name of the "people." His moves are guaranteed to destroy that country economically. So, it was with significant trepidation that I chose to trust the mfi system and bought HNR.

It wallowed around break-even to a slight loss, which I considered an achievement in itself. I had decided that I would be ecstatic if I didn't lose more than 10% on that particular stock.

Well, today, the Venezuelan National Assembly approved its contract with HNR and voted to release significant funds that were due to HNR in arrears. The result is that the shares surged over 37% today, placing me at a 33.28% gain since early January.

Now, anything can happen, especially in Venezuela under that thug. For all I know, in two days, he'll decide this was a bad thing and will reverse it, because laws and property rights mean nothing to him. But, for now, it goes to show that it's a good thing I don't actually pick 'em. Because I absolutely would have missed this one. Now, my natural inclination is to pocket this gain, but I will continue to follow MFI.

-A

Weighted gain since inception (3/6/06) 28.59% vs. S&P 500 14.67%

Cellstar

Here's an interesting one in my portfolio, and an example of why diversification is so important. Cellstar Holdings (CLHI) entered my portfolio in November 2006, under my random method. It has proceeded to lose 28.86% of its value, through 6/15/07. Now, I check the stocks daily to see what they're doing and noticed that this one, after declining, was barely moving at all. So, I started to look into it and determined that this company is in liquidation! This past week, CLHI announced that they had completed selling substantially all their assets and all that was left was the collection of some minor notes receivable, which were expected to be collected by the end of this year. The stock price barely reacted to this news.


Here's the interesting thing. CLHI is still on magicformulainvesting.com . I read recently about the risk, in value investing, of "underpriced" stocks which will remain underpriced. Presumably, the reason CLHI stays at this price is because it's at its liquidation value. However, utilizing the prior year's earnings indicates that the stock still sells at some multiple of earnings that places it high in the mfi universe. However, the price will never increase because it is already at its liquidation value. There is, in actuality, no goodwill to be had.


Now, this news may have already been available when I purchased the stock (although I can see the initial proxy statement proposing dissolution was from 2/07), some might say why didn't I do a little research to determine if this kind of risk was out there? Well, you could just as easily argue, why didn't I do some research on other MFI stocks and not miss a certain winner? That's not the point. I readily acknowledge that I don't have the time or the inclination to research these stocks. I am following the strategy of MFI, not becoming a guru. The MFI strategy struck a chord with me the instant I read about it, and its appeal has not diminished in my eyes, even with CLHI, FORD, and a couple of other "losers." Without it, I would never have even known about PNCL and WNR, which have alone made up for these losses.


MFI Fund price as of 6/15 = $55.09, up 40.41% over 6/15/06 vs. a 22.03% gain for the S&P 500.

Fording Canadian Coal Trust

FDG continues to intrigue me as a story of the power of mfi. It took a lot of hemming and hawing for me to decide to keep FDG when a year was up. I was at nearly a 23% loss for the year of holding the stock and it had barely budged from that performance. Yet, when it came time to choose 5 new stocks, there it was, still in the list. This was in May. Now in March, which was my one year anniversary of MFI, PNCL was still in the list and was up for sale in my March batch. random.org managed to pick PNCL again, so I didn't need to think about whether I wanted to hold a stock still in the list. But in May, FDG was not picked by random.org and I had to make the call. Do I deviate from my strategy of being purely random, or do I give the system a chance, since it was still a "top" stock?

When PNCL had been up for renewal, I knew I wanted to let it keep riding since it was still in the MFI list. (As of 6/15, it was up 10.6% since March). I had been thinking about this for many months before my first anniversary date. The mfi website says it's purely up to you if you want to keep a stock still on the list. I had been leaning towards doing that for months. But, FDG was the first stock to challenge this idea. Ultimately, I decided I would go with it. So, not only did I keep it, but I bought more, because it was now underweighted due to its losses (and also because I'm investing more in MFI this second year, to make it 25% of my entire investment portfolio. Regardless of its successes thus far, and I hope it will continue, I would never let 30 stocks be a larger amount of my portfolio. The rest of my family's portfolio are in diversified mutual funds and a couple of other stocks, picked for specific reasons and surprisingly doing well).

Right after I "re-bought" it, FDG started to rise. In fact, not only is it profitable since May, but as of Friday, it has regained ALL of the losses from 5/06 - 5/07. The increase since early May is 21.31%. While it's only at a weighted gain since 5/06 of 4.68%, it's still a testament to the power of mfi.

Slightly over three weeks to my third buy/sell date, 7/9.

A new analysis

Now, I tried a new step, which was to calculate cumulative gains as compared to the S&P 500, weighted for additional funds committed at different times for the MFI portfolio. Since 3/06, my weighted return is 25.01% (this is total return, not annual return), vs. a weighted total return for the S&P 500 for the same period of 13.51%. Nice!

For context, if my initial investment were calculated as the proverbial $10,000, and each additional investment weighted the same way, total cost of investments to date would be $57,754. Under MFI, I would have $72,199 and under the S&P 500 I would have $65,559, a difference of $6,640 in only a year and 3 1/2 months.

Or if all that was invested was the proverbial $10,000, it would currently be worth $12,501 vs. $11,351 for the S&P 500. Any way you slice it, it's all the same. Again...let's see in three years, but so far great.

-A

MFI Fund Price per Share

For a little bit of entertainment, and because I apparently am very anal when it comes to tracking performance, I set up a calculation of what the price per share would be if my portfolio was a fund...not exactly the same as a fund though. Dividends and capital gains are not distributed (which would approximate a fund in which everyone reinvests dividends and capital gains) and there are no expenses charged. I'm then comparing it to the S&P 500 (which I'm still not sure if it reflects dividends reinvested. I think it does, but I'm not sure. Does anyone know?). If the S&P 500 includes reinvested dividends, and since it doesn't include any expenses, it's a fairly good measure.

So, price at inception for my MFI fund = $42.97 (I took an arbitrary # of shs outstanding, which I won't reveal here). Date of inception was 3/6/06. S&P 500 on that date was $1,278.26.

MFI price at close 6/11/07 = $53.93. 25.52% since inception.
S&P 500 6/11/07 = $1,509.12, 18.06% since 3/6/06.

Now, of course, entry date makes all the difference. At some point soon, for the heck of it, I'll show monthly closes.

I'm showing all this because if there are people out there like me, they're looking to see if people are having success with the MFI method. So far, at least, the answer is a resounding yes. Not far enough along to be "scientific" yet, but at least it's a start.

-A

How I encountered MFI

I've been reading Smart Money for years, but had never done much investing in individual stocks. In fact, I usually skipped the individual investment sections and went to the back and read about ways to save, long-term financial planning, etc. However, I always skimmed the investment sections, particularly the stock screen article.


Around February 2006, they had an article where they ran a stock screen using mfi. I was intrigued by the general concept and dropped their stock picks into a tracking portfolio. Then I picked up the book and was even more intrigued. I started playing around with a couple of "test" portfolios, where I tried to be clever as to how to pick them. First, I tried to only pick the top earnings yield, but only if the ROC was greater than 100%. Then, I tried my hand at doing a little research on the stocks.


When I bought my first tranche in March 2006, I used a combination. First, I picked American Eagle Outfitters (AEO) b/c that was on the Smart Money screen, had done very well already, and was still on MFI. I know I missed a nice run up, but I figured I'd try it since it was still there. Ultimately, I did well...a year later I closed that position with a 50% gain. But, I mostly used the system of picking the best earnings yields. I ended up with Forward Industries (FORD), as a result. 50% loss! Ugly! (Had I kept it past a year, it would now be at a 63% loss. Complete stinker). The saving grace was the purchase of Pinnacle Airlines (PNCL), which I ended up closing with a 145% gain. Very nice.


At the same time as this, I continued to try test portfolios. I found that the best thing I could do was enter no bias into it whatsoever. So, by the second buy in May 2006, I went completely random, courtesy of random.org, which is a ridiculously fun website. Let me declare what a geek I am to the world. I had previously used this site to shuffle up my 750 cd collection to force me to listen to albums I hadn't listened to in a while. GEEK.


Well, now what I did was put in my parameters in mfi.com: 25 top picks over $50M market cap. I'd use random.org to randomly shuffle the sequence of 1 - 25. Then, I'd start going right down the list in order, skipping only stocks that I already owned.


The results? Well, very, very good so far as you can see from my earlier post. My May 2006 block of stocks did 27% vs. 15% for my benchmark. There were two early cash mergers (Kerr McGee (KMG) and Portalplayer (PLAY)) which both did well. Marvel (MVL) and Viropharma (VPHM) were great and my only stinker was Fording Canadian Coal Trust (FDG).


Fording actually ended up being an interesting one...I lost money on that one in a year, but it was still in the screen when it was time to buy new stocks and I chose to keep it (and, since it was down, even had to buy more). Interestingly, at this point, not only is it up, but it has almost recovered everything I lost from 5/06 to 5/07. Maybe there's something to this MFI thing after all! :)


More on the background to come before we can move forward...


-A

Quick comment on the portfolio

It may look strange that I included 2 closed positions on my open positions spreadsheet. They're included because I was really looking to show each tranche. Those two were acquired with tranches that are still open.

There are other people out there!

I was interested to discover the various blogs of people doing the magic formula investing thing. My first thought is these guys are much more sophisticated than me. I have a lot of respect for the knowledge and in depth analysis everyone else is doing. However, my second thought was that many people seem to be trying alternatives to the system set up by Joel Greenblatt. I started my MFI portfolio in March 2006 and I have been very happy with the results so far. Now, I fully realize it could be pure luck. But, it could also be that I am strictly following the guidelines in the book.

I have a friend who read the book and then said he could never do it because he's too much of a gambler. And, I'll admit, the temptation is always there. i.e.:

1. Hey! This stock is up tons, let's take the profit now!

2. This stock stinks. Time to dump.

3. This stock is doing so well, a year is up, and it's not on the MFI website anymore. Let's keep it anyway!

But, I always remind myself, don't try to time the market and don't try to be clever. I say to myself, "Self, BE DISCIPLINED!". So far, it has paid off. The purpose of this blog will be to share the results of strictly following the plan in the book. All forward looking, no back-testing.

Here's my current portfolio and results:

Sorry for the ugly looking post...it's my first one. It will be interesting to watch how this portfolio continues to do over a three year period. In theory since I'm pretty far ahead of the benchmark, one would expect that I will likely underperform for a period to bring it back to average. We'll see.

Next posts will talk about my HIGHLY SOPHISTICATED method of picking 'em and some of the thoughts I've had on the investments.

-A