Here’s a quick way to improve the results of Joel Greenblatt’s Magic Formula

//Here’s a quick way to improve the results of Joel Greenblatt’s Magic Formula

Here’s a quick way to improve the results of Joel Greenblatt’s Magic Formula

 

Long time readers know I am a big fan of the Magic Formula investment strategy developed by Joel Greenblatt in his excellent book The Little Book that Still Beats the Market. (Click for Amazon page)

As you may know the Magic Formula strategy is a pure strategy based on numbers.

This means that there are also a lot of junk companies that come up when you use the formula.

Companies with large once-off profits, high historical profits that may not be repeated due to a contract loss. You know what I mean.

I always thought that the already excellent returns of the strategy can be further improved by removing the companies the Magic Formula should not be selecting.

Doing this however takes a lot of time.

You have to look at the financial statements of the company and read annual as well as quarterly reports. Not just for one year but for the last few years to find out exactly what is going on in the business.

Because all of us are pressed for time I was really glad when I found someone that does exactly that.

And for you to get to know him better I interviewed him.

His name is Steve Alexander and he writes an excellent investment newsletter where he adds value to the already good investment ideas the Magic Formula comes up with.

Steve’s website can be found here MagicDiligence – the Best Magic Formula Stocks

If you invest only in the US markets Steve’s newsletter is something you may want to consider as all the companies he analyses are in the USA.

 

Take advantage of the free trial Steve offers to see if you like his ideas.

Full disclosure – I really do like Steve and his ideas are very good, but I will be paid a small commission if you decide to subscribe to his newsletter.

Now for the interview

 

 

How did you get started in investing?

Steve Alexander: Business was always a keen interest of mine, nurtured by reading stories about Henry Ford, Lee Iacocca, John Rockefeller, etc.  Studying business naturally led into an interest in analyzing stocks.

 

 

Can you talk about your investment approach and how it has developed over time?

Steve Alexander: Like a lot of value investors, my original approach was to try and find great long term businesses and ride them indefinitely – the Warren Buffett method of investing.  While this was mostly successful, I found that it often led to holding overvalued stocks when I knew I could probably sell and get back in at a lower price.  So Greenblatt’s strategy made a great deal of sense to me from both a business and valuation perspective.  Since starting MagicDiligence, I’ve also incorporated in some other very successful strategies to help filter the MFI stock lists further.

 

 

How did you weather 2008 and the first part of 2009?

Steve Alexander: The Magic Formula strategy is basically always fully invested.  So we went down, like everyone else, although at a slower pace than the market.  Staying fully invested did allow us to fully benefit from the now 100%+ market recovery since March of 2009.  A lot of folks got stuck in cash during the rebound.

 
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How do you typically find ideas and what is your selection process before an idea gets added to your portfolio?

Steve Alexander: My stock universe is the Magic Formula screens – that’s my canvas.  From there, I usually have a quick look at the balance sheet, revenue growth over the past few years, price momentum, read a quick synopsis of the business.  If all of those quick look things pass, I’ll go into more detail and work up a formal estimation of fair value, look for any red flags in the filings, etc.

 

 

How many positions do you typically have in your portfolio?

Steve Alexander: In my personal portfolio, usually 10-15.  MagicDiligence does a pick bi-weekly, so there are usually 25-30 picks active there at any given time.

 

 

What are your ideas concerning portfolio composition and the value of individual holdings in relation to the portfolio?

Steve Alexander: I never understood the dogma surrounding the percentages of bonds, gold, stocks, whatever.  If you know something really well, why would you di-worsify into things you wouldn’t understand as well?  My portfolio is in stocks or cash.  Within stocks you can focus on things like conservative dividend players vs. high-upside, high-risk picks.

 

 

Describe some of your most notable investment mistakes and what did you learn from them?

Steve Alexander: This one is easy.  I recommended a few of the Chinese small-cap reverse merger stocks last year.  From a statistical and analytical perspective, they were and continue to be incredibly cheap, and have reported outstanding growth.

But then, after following them, you see management doing head-scratching things like issuing huge amounts of stock, even with large net cash balances.  And you see the damage that unsubstantiated reports from short sellers can do to those positions.

Given that, I learned to avoid vulnerable short-seller targets and to always ensure that the reported numbers are audited by respected firms, especially for small-caps.

 

 

Do you follow any key risk-management guidelines in managing your portfolio?

Steve Alexander: MagicDiligence has distinct “conservative” and “aggressive” portfolios.  By keeping these balanced, you have conservative dividend-paying stocks to fall back on if some of the fast growers stumble.

Also, the “sell early” price target should help prevent getting caught in valuation corrections.

 

 

What is the current geographic mix of your portfolio?

Steve Alexander: Well, it’s all U.S.-listed stocks, as per the strategy.  Many of the picks do a majority of business outside of the U.S.

 

 

How do you manage currency exposures?

Steve Alexander: Nothing active on my side.  I let my CEOs worry about that!

 

 

How did you get involved in writing an investment blog?

Steve Alexander: It started by contributing to (respectable) investment message boards.  A lot of my detailed posts got a lot of “likes” or “rep”, so I thought starting my own blog might be useful.

I always enjoyed reading stock newsletters and knew I could do as well or better of a job than a lot of them.

 

 

What has been your most notable success while blogging and why?

Steve Alexander: It’s gratifying to see a lot of my small-cap reviews of stocks nobody has ever heard off take off.

For example, I positively reviewed Acme Packet (APKT) back when it was $5 in July of 2008.  It’s over $70 today.

Or Motorcar Parts (MPAA), which was just about $6 when I reviewed it back in August, vs. almost $15 today.

 

 

What has been your most read blog posts and why?

Steve Alexander: The ones that go into detail explaining the 3 financial statements are the most read.  I think they address some of the common questions that new investors have every day.  Also, those are less time-sensitive posts that are still relevant years from now.

 

 

Who do you think I should interview next?

Steve Alexander: I hear LeBron James is an avid investor…

 

 

Steve, thanks for your time and insights

Steve Alexander: Thanks Tim, best of luck!

 

Here is that link to Steve’s website again MagicDiligence – the Best Magic Formula Stocks

 

Your Magic Formula analyst

 

Tim_sign3