China Margin Trades Buckle Leaving $364 Billion at Risk

by Fox HuKana Nishizawa

The biggest tumble in Chinese shares since 2008 is proving especially painful for margin traders as their favorite stocks sink faster than the benchmark index, raising the risk of forced liquidations.

The 30 equities in Shanghai with the highest levels of margin debt relative to tradable shares have dropped 17 percent on average since the market peaked on June 12, versus a 13 percent decline for the Shanghai Composite Index. Margin positions on the city’s bourse fell for the first time in a month on Friday, a sign that leveraged investors are unwinding bets after they grew more than five-fold in the past year.

With at least $364 billion of borrowed money riding on stocks in Shanghai and Shenzhen, losses on those positions threaten to magnify market declines as traders sell shares to meet margin calls. China’s benchmark index tumbled at the fastest pace among global equity gauges last week, after a world-beating 152 percent gain in the previous 12 months.

“It’s a self-fulfilling prophecy,” Roshan Padamadan, the founder and manager of Luminance Global Fund, said in an interview on Bloomberg Television from Singapore. “As people try to book profits, they’ll find out that there’s nobody on the other side of the trade.”

EGing Photovoltaic Technology Co., a Chinese solar-equipment maker in eastern Jiangsu province, dropped 21 percent since June 12 after outstanding margin bets climbed to 44 percent of the company’s free-float adjusted market capitalization, the highest level among more than 480 equities tracked by Bloomberg and the Shanghai Stock Exchange.

Margin Call

Shanghai Construction Group Co., with a margin trade ratio of about 34 percent, has retreated 19 percent, paring gains over the past year to 243 percent. Shenzhen-based Joincare Pharmaceutical Group Industry Co. declined 20 percent after margin bets reached almost 27 percent of free float.

In a margin trade, investors use their own money for just a portion of the stock purchase, borrowing the rest from a brokerage. The loans are backed by the investors’ equity holdings, meaning they may be compelled to sell to repay their debt when prices fall.

“You can see from Friday’s sharp decline that people are already cutting losses on margin trading,” said Mari Oshidari, a Hong Kong-based strategist at Okasan Securities Group Inc. “This is still ongoing, so we should watch out for further selling pressure.”

While margin debt has surged in recent months, it’s still at manageable levels relative to the size of China’s $8.8 trillion stock market, according to Aaron Boesky, the chief executive officer at Marco Polo Pure Asset Management, which runs a China-focused hedge fund.

Rally Forecast

Investors should take advantage of market declines to increase holdings, Boesky said, anticipating the Shanghai Composite may rally another 36 percent to surpass its all-time high in October 2007.

“It is best to buy the dips,” he said in an e-mail on June 21. “Consolidation allows for those already high returns to sell and take profit, and those who have resisted jumping into the market to now have an appetizing entry point.”

Margin traders have been such an important source of demand for Chinese shares that any pullback, particularly one caused by regulatory efforts to curb the use of leverage, will weigh on the market, according to Ronald Wan, the chief executive officer of Partners Capital International in Hong Kong.

Almost all of this year’s biggest declines in the Shanghai Composite, including a 6.5 percent slump on May 28, were sparked by investor concerns over margin-trading restrictions.

The China Securities Regulatory Commission is planning to curb the amount of margin trades and short sales financed by brokerages to no more than four times their net capital, according to draft rules posted on its website June 12. Brokerages including GF Securities Co. and Haitong Securities Co. have already tightened lending requirements to limit their exposure to any market downturn.

Chinese stocks have been “heavily reliant on margin financing,” Wan said in an interview on Bloomberg Television. “If the government actually cracks down on certain forms of financing, a correction is unavoidable.”

http://www.bloomberg.com/news/articles/2015-06-22/china-margin-trades-buckle-as-selloff-puts-364-billion-at-risk

Interest rates rise likely to increase market volatility

Question:  Interest rates are expected to rise at some point this year, and with that increase, there’s likely to be increased volatility in the equity market.

Given that environment, what types of investments should individual investors consider if they’re seeking a return greater than what a CD or money market account would offer? 

Answer:   Typically, fixed income prices (e.g. bonds, treasuries, etc.) tend to decrease as overall interest rates rise.

However, there are certain kinds of income-producing investments whose prices may not be as volatile should rates begin to rise and could potentially offer higher current income (e.g. floating rate bonds, high yield bonds, and Treasury Inflation Protected Securities “TIPS”, etc.) 

While typically more volatile than bonds, there are many stocks whose dividends (income stream), have risen faster than inflation. 

Question:   Many sophisticated investors make investments in riskier asset classes to generate returns that outpace those of the stock market and traditional investments. What is your view on alternative investments, and do they have a place in the individual investor's portfolio?  

Answer:   Often, when one asset class (i.e. one kind of investment) increases, another decreases. Stocks and bonds, for example, often behave this way. 

Because of this relationship, allocating a certain percentage of one’s portfolio to stocks and a certain percentage to bonds, potentially reduces volatility of the overall portfolio. 

Sometimes—like in 2008—stocks and bonds can both decline together. 

Alternative investments are those that do not necessarily increase or decrease in relation to stocks or bonds. 

For example, some alternative investments increased in value during the financial crisis. 

Adding alternatives to a portfolio may help create additional diversification. This in turn could potentially give the portfolio a “smoother ride”. Alternative Investments can be complex, so it’s important to match the right investment with an investor’s specific objectives. 

Question: What type of alternative investments are easiest for individual investors to invest in and which may also offer some risk mitigation?

Answer: All these alternatives fall into their own specific framework. There are specific rules governing who is allowed to invest in them. Typically they are for higher net worth investors with extensive portfolios in need of additional diversification.


Securing a comfortable retirement is a ubiquitous goal for many investors. 

Inflation risk, interest rate risk and principal risk

Typically, investors think of 3 basic risk types—inflation risk, interest rate risk, and principal risk. 


In fact, there’s no such thing as a riskless investment. 

While US Treasuries guarantee a return of your principal, they are subject to inflation risk (the risk that a dollar today may be worth less than a dollar tomorrow). 

If you keep cash under your mattress, you not only have inflation risk but you also have risk of fire and theft. 

Stocks may potentially reduce inflation risk but have a higher level of capital risk (i.e. if you invest in stocks, you can lose money).

When you substitute one kind of risk, you open yourself up to another. 


There are ways to eliminate or at least diminish certain kinds of risks while maintaining long-term objectives. 

An investor could simply not invest as much in vehicles that have risk to principal, like stocks. 

Or, they could allocate more money to principal-protected investments. 

Since investment returns are typically a function of how much risk you are willing to assume, the lower the risk, the lower the returns. 

That said, there are investments designed to give an investor some exposure to the stock market, while guaranteeing a stream of income during retirement. These typically have liquidity risk.  In other words, you might not be able to access your money for a certain period of time. 


 

Does the Magic Formula Really Work?

What You Will Learn

• Understanding what the Magic Formula is and how to use it
• Performance of the Magic Formula and whether it is achievable
• Whether the Magic Formula is worth using going forward

Magic.

That’s what you need to beat the market and that’s what the Magic Formula is supposed to do.

As a result of brilliant marketing, promotion and becoming a New York Times bestseller in 2005, Joel Greenblatt has turned the Magic Formula into a key strategy for many in the value investing and mechanical investing community.

Buy at least 20 stocks from the Magic Formula screening tooland then rebalance at the end of the year. Do this and you will beat the market, the book says.

The Little Book that Beats the Market

Greenblatt wrote The Little Book that Beats the Market for his children who were aged between 6-15 at the time.

It’s written in plain English and 6th grade math to make it easy to follow along. This is the strong point of the Magic Formula theme.

Everything is very easy to understand. The concept is simple, the explanation is simple, but most important of all, the execution for investors is simple enough to do on their own.

In it’s most naked form, the Magic Formula is described by Greenblatt as

a long-term investment strategy designed to help investors buy a group of above-average companies but only when they are available at below-average prices.

The Ingredients to the Magic Formula

Here is the formula courtesy of wikipedia. From beginning to end, it consists of 9 steps.

1. Establish a minimum market capitalization (usually greater than $50 million).
2. Exclude utility and financial stocks
3. Exclude foreign companies (American Depositary Receipts)
4. Determine company’s earnings yield = EBIT / enterprise value.
5. Determine company’s return on capital = ebit / (net fixed assets + working capital)
6. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages).
7. Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period.
8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
9. Continue over a long-term (3–5+ year) period.

Pay close attention to step 4 and 5 because they are the key driving formulas for it all to work.

• Earnings Yield = EBIT / Enterprise Value
• Return on Capital = EBIT / (Net Fixed Assets + Working Capital)

Earnings Yield is used because it targets companies with below-average prices. The idea behind of Return on Capital is to select good companies that are outperforming. This fits in line with what Greenblatt said

a long-term investment strategy designed to help investors buy a group of above-average companies but only when they are available at below-average prices.

The Magical Performance

So how magic is this Magic Formula in terms of performance? This table of values is from the revised 2010 version of the book.

and a better representation.

Starting with $10,000 the Magic Formula would have made you a millionaire by 2009.

The Magic Formula is famous for returning a 30% CAGR. From 1988 to 2004, it did achieve a 30.8% return, but the CAGR has declined significantly. No strategy can sustain a CAGR of 30%. Although the backtest in the book only provides data up to 2009, I wouldn’t count on 2010-2012 results showing vast out-performance.

The Magic Formula is a Fraud?

By popular demand, the Magic Formula will soon be added to the list of value stock screens, but the one thing that has held it back is the reliability of the backtest performed by Greenblatt.

I just don’t believe the results are as good as it seems.

What’s more, other blogs have tried to simulate the Magic Formula performance from the book, but none of them  have come close.

• Magic Formula that JUST beats the market
• Turnkey Analyst tests the Magic Formula
• Another article suggesting that the Magic Formula beats the market by 4.5%

Read more: http://www.oldschoolvalue.com/blog/investing-strategy/the-magic-formula-investing/#ixzz3cvbPJIfM

Warren Buffett’s Greatest Competition

There’s no disputing that Warren Buffett is the best investor of all time. His net worth speaks for itself. In fact, there is only one person in history worthy of comparison.

That person is young Warren Buffett.

Let’s take a look at the numbers Buffett achieved in the 1950s and 1960s compared to his performance thereafter.

From 1957 to 1969, Buffett achieved an average return of 29.5% and a cumulative return of 2794.9%!

In this timeframe, the Dow had a negative return in 5 out 12 years. Buffett had a positive return in all 12 years, with his most successful year, 1968, reaching a remarkable 58.8%. That beat the Dow by more than 50 percentage points.

This was the pinnacle of Buffett utilizing the strategies of Benjamin Graham and investing in net net stocks. He focused on the best possible NCAV investments, such as Western Insurance Securities Company, and often chose fairly concentrated portfolios. Once he found the stocks, he simply puffed the cigar and celebrated his victories.

Back then, finding these valuable, cheap companies was difficult. Young Warren Buffett had to do his own research and put in relentless man-hours. He spent months combing through Moody's stock manuals to find a handful of available net nets. Today, you can find a good selection of high-quality international net net stocks by signing up for free net net stock picks or, even better, opting for full access to Net Net Hunter.

For comparison, between the years of 1965 and 2014 when Warren Buffett became a behemoth, Berkshire achieved a compounded annual return of 19.4%, over 10% less than the best years of his investment life. And, these numbers were heavily boosted by the returns young Warren Buffett achieved in the late 1960s. During this timespan, he also had a few negative years and a few more in which the S&P 500 outperformed his portfolio.

A return of 19.4% annually is nothing to sneeze at. Most investors do worse. Still, 84-year-old billionaire Warren Buffett wouldn’t last a round in the ring with his agile, quick-footed 30-year-old self. At a Berkshire Hathaway annual meeting, he admitted it:

"Yeah, if I were working with small sums, I certainly would be much more inclined to look among what you might call classic Graham stocks, very low PEs and maybe below working capital and all that. Although -- and incidentally I would do far better percentage wise if I were working with small sums -- there are just way more opportunities. If you're working with a small sum you have thousands and thousands of potential opportunities and when we work with large sums, we just -- we have relatively few possibilities in the investment world which can make a real difference in our net worth. So, you have a huge advantage over me if you're working with very little money." – Warren Buffett

You have thousands and thousands of potential opportunities that Buffett does not! By being able to invest in net net stocks, classic Graham stocks, you have a huge advantage over the Oracle of Omaha.

Following Benjamin Graham and a Young Warren Buffett

So, this brings us back to the beginning. A young Warren Buffett risked everything and hopped on a train to Washington D.C. to work for Benjamin Graham, the father of value investing.

In 1954, he accepted a job at Graham’s partnership for a starting salary of $12,000 a year. Under Graham’s tutelage, he fine-tuned his ability to spot promising net net stocks, as opposed to merely cheap stocks.

Both are obviously value stocks, but cheap stocks can be any stock where the current price is lower than the underlying intrinsic value. Net net stocks are valued purely on their net current assets. That’s cash, accounts receivable, and inventory minus total liabilities, preferred shares, and various off-balance sheet liabilities. Working capital. This is better known as the NCAV, or Net Current Asset Value.

If the stock price was 2/3 of the NCAV, Graham would buy. When the stock price returned to the full NCAV, Graham would sell. Assuming he found a good net net stock, his downside is protected by the discount to net liquid assets, providing a huge margin of safety. It’s such a solid strategy that you, as a small investor, don’t really have to know a thing about the industry. By comparison, Buffett went into textiles in a major way and lost his shirt.

There have been multiple studies that show Graham’s strategy consistently shows returns of a basket of net net stocks in the 20-35% range. From 1970 to 1983, an investor could have earned an average return of 29.4% by purchasing stocks that fulfilled Graham’s requirements and holding them for at least a year.

Buffett himself, using Graham’s strategy, stated that he would see returns within a 2-year timeframe 70 to 80% of the time. He would take a puff and sell instead of collecting boxes of cigars and waiting for them to appreciate in value.

Despite the simplicity of his approach, it seems most investors ignore the stocks that Graham would have most coveted. Investors nowadays want to invest as if they’re billionaires, choosing a wide range of large cap stocks and holding on to them until retirement, death, or the next big market crash.

Going against the market takes conviction and faith in your approach, something both Graham and Buffett had in spades. Smart value investors don’t brag about owning Apple or Google. They talk about small wholesale electronics factories and unknown retail companies. They are excited about international microcap stocks in Japan or Australia.

If you’ve read this far, you’re not Warren Buffett, the immobile billionaire. You’re young Warren Buffett, the wide-eyed investor hopping on a train heading toward immeasurable wealth.

Read more here:

http://www.netnethunter.com/how-young-warren-buffett-started-his-fortune/

Is Benjamin Graham Still Relevant in 2015?

 Benjamin Graham in the Shadow of Buffettology?

Part of the question of whether Benjamin Graham is still relevant today arises from the popularity and success of Warren Buffett. During the course of his career, Buffett has essential blazed a trail away from the core strategies of Benjamin Graham. He's been quite successful, too, recording returns much higher than Benjamin Graham ever did.

Buffett's most recent plain vanilla approach to investing involves buying good companies at good prices and not looking for the statistical bargains that Graham advocated. Instead of buying bargains and selling them when they rise back to fair value, Buffett mostly holds onto his stocks forever.

Buffett has also spent a lot of time talking to the press and students about investing and business, which has lead many people to adopt the contemporary Buffett approach to investing.

Investors should definitely keep two things in mind when it comes to Buffettology, however. First, Buffett's investment philosophy is still rooted in the philosophy of Benjamin Graham and, second, Buffett racked up his biggest returns in the 1950s and 1960s when he was still using Benjamin Graham's investment philosophy.

Buffett still uses significant aspects of Graham's approach -- specifically the focus on valuation. All of his investment decisions involve judging the value of the business and then using that value as the bedrock from which he assesses the investment's merit. Bad things can happen to your net worth when you buy great companies at expensive prices. He also recognizes that reversion to the mean is nearly a fundamental law in business so looks to ways to protect himself by buying firms with strong competitive advantages.

Despite Buffett's great long term track record, his Buffett Partnership letters reveal that he was achieving his highest returns while he was using Benjamin Graham's classic value investing approach -- the cornerstone of which was Graham's net net stock strategy. During the 1950s and 1960s he earned returns of roughly 30%, and only changed his strategy when his portfolio became to large to continue buying net net stocks.

Warren Buffett had the best results of his career during his partnership days. His later returns had to be much lower to drag down his average returns to 20%.

After the change, while Buffett still earned outstanding results, they were not nearly as good as they were before the change in investment strategy. It's worth noting that even now Buffett would chose to use a classic Benjamin Graham approach to value investing if he was managing a portfolio under $10 million.

Read more here:

http://www.netnethunter.com/benjamin-graham-still-relevant-or-a-complete-waste-of-time/

Joel Greenblatt’s Forgotten Original Magic Formula

Joel Greenblatt has one of the best records on Wall Street. Aside from being an adjunct professor at Columbia University Graduate School of Business, he's also well entrenched in the Hedge Fund industry through his management of Gotham Capital. From 1985 to 2005, Greenblatt is reported to have racked up an even better record than Warren Buffett did during his partnership days, earning 48.5% compounded over 10 years through a combination of special situation and deep value investing.

If you've heard about Joel Greenblatt, it's probably due to his widely read book, "The Little Book That Beats the Market". In it, Greenblatt makes the case for a formula that investors can use to achieve superior results over the long run. Essentially, the formula looks for businesses with a large earnings yield and a high return on capital. The premise is that, over the long run, stocks of firms that are both cheap and good would vastly outperform the stocks of firms that are just cheap -- and it definitely seems to have worked. As Greenblatt reported in his book, from 1988 to 2009 the magic formula produced a CAGR of 23.8% versus a 9.6% CAGR for the S&P 500.

The Original Magic Formula

Joel Greenblatt's love for cheap stocks of good companies started long before he developed his latest Magic Formula, however.

It's probably no surprise that the backbone of Joel Greenblatt's original magic formula rested on Benjamin Graham's net net stocks strategy. Greenblatt had been following Graham for years, carefully studying the principles and philosophies of the Dean of Wall Street, and was deeply impressed by, in his words, "the dramatic success of companies that the market priced below their value in liquidation...".

Benjamin Graham's own NCAV stocks strategy was to buy a diversified list of net net stocks that were trading at least 1/3rd below their net current asset value. Graham screened out stocks that failed to show a decent past record and those that were losing money. By putting together a diversified list, Graham hoped to take advantage of the population returns of net net stocks and ride that fantastic statistical record to great profits.

In 1981, at just 24 years old, Joel Greenblatt teamed up with Richard Pzena (a great value investor in his own right), and Bruce Newberg to test their own version of Graham's NCAV investing approach. The result was a fantastic research paper called, "How the Small Investor Can Beat the Market: By Buying Stocks That Are Selling Below Their Liquidation Value" (The Journal of Portfolio Management 1981.7.4:48-52).

Defining Net Current Asset Value

According to Joel Greenblatt:

Current Assets (Cash, Accounts Receivable, Inventory, etc.), less…

Current Liabilities (Short Term Debt, Accounts Payable, etc), less…

Long Term Liabilities (Long Term Debt, Capitalized leases, etc), less…

Preferred Stock (Claims On Corporate Assets Before Common Stock)…

Divided by the Number of Shares Outstanding…

Equals Liquidating Value Per Share (NCAV Per Share).

In his paper, Joel Greenblatt wondered what would happen if he carved up the world of net net stocks even further, eliminating a lot of the terrible firms from contention. To do this he turned to one of the most widely recognized valuation metric in value investing: the PE ratio.

Using both Graham's net current asset value and value investing's classic PE ratio, he put together 4 different portfolios and compared those portfolios against the OTC and Value Line's own value index from 1972 to 1978. According to Joel Greenblatt, this period was characterized by an extreme amount of volatility which made for a much more robust test.

To select the stocks, Greenblatt only looked at firms in the Standard and Poor's Stock Guide with market caps of over $3 million and names that started with either an A or a B. He then drew net net stocks from the roughly 750 candidates left in order to put together his model portfolios.

Portfolio 1 Price below NCAV PE floating with corporate bond yields No dividends required	Portfolio 2 Price below 85% of NCAV PE floating with corporate bond yields No dividends required
Portfolio 3 Price below NCAV PE of less than 5x No dividends required	Portfolio 4 Price below 85% of NCAV PE of less than 5x No dividends required

Purchases were made based on the above criteria. Stocks were sold after a 100% gain or two years had passed, whichever resulted first. The portfolios themselves were equal weighted, so the actual yearly returns of each portfolio were just the average returns of the stocks within each portfolio.

All of the portfolios beat the indexes by a wide margin. By combining liquidation value with smaller PE ratios, however, results exploded.

Take a look at portfolio #4. The CAGR of portfolio #4, Greenblatt's original Magic Formula, blew the market away. While the OTC CAGR totalled just 1.3% for the 6 year period, and the Value Line index came to a slight loss, Joel Greenblatt's original Magic Formula was up over 42% compounded per year from August 1973 to April 1978!

Greenblatt et al even included returns after commissions and taxes, for those of you who aren't holding your portfolio in a tax free retirement account for some strange reason. Re-examined, Greenblatt's best performing portfolio still destroyed the market, up over 29% versus flat returns for the indexers.

It's important to realize what this means for average investors. Since the American market indexes return roughly 10% per year on average, Greenblatt's forgotten original Magic Formula should be good for between 29% and 39% on average over the long run.

Granted, Greenblatt's study only covered a period of 6 years, but in my experience buying net net stocks with tiny PE ratios has proven to be a very profitable strategy. In fact, most of my best performing stocks have been these sort of net nets. Also keep in mind just how tumultuous the markets were during that period which, as Greenblatt wrote, made for a much more robust test.

(As an aside: if you're stuck holding your funds outside a tax shelter, for some reason, you can boost the tax efficiency of your portfolio by just holding your stocks for longer. This becomes a lot more viable if you're investing in the highest quality net nets.)

Three Major Takeaways from Joel Greenblatt's Study

It's hard to argue with returns like that.

Still, the more observant of you might have noticed a few potential flaws with the study and results.

At first glance, it definitely appears that you can't hold a large number of stocks in a portfolio using Joel Greenblatt's criteria. If you look to the right of each period's return, you'll see exactly how many stocks he held. In fact, Greenblatt et al were out of the market entirely for a lot of 1972 and 1973.

I don't think this is a crippling flaw to his strategy at all, however.

It's important to realize that Benjamin Graham's obsession with wide diversification isn't really necessary. In Joel Greenblatt's first book, "You can Be a Stock Market Genius," he argues that you need fewer than 10 stocks to eliminate most of the systemic risk that you face while investing in stocks. Ultimately, you don't need 30 or 100 different stocks to diversify away most of your risk. You can do it with ten.

You can even leverage Greenblatt's original Magic Formula, portfolio #4, while maintaining a fully stocked portfolio during the upper reaches of a bull market. The trick is to put together a portfolio of other net net stocks and then replace the weakest links in your portfolio with a portfolio #4 type net net when new candidates become available. Doing so would allow you to leverage the returns of NCAV stocks as a group while still employing Greenblatt's original magic formula when available.

You could even chose the best net net stocks that don't meet Greenblatt's criteria by focusing on NCAV stocks that are trading at an incredibly cheap price to NCAV, have no debt, are growing NCAV per share, are buying back stock, or which have insiders who are buying big blocks of shares, themselves.

Lastly, remember that Joel Greenblatt et al only looked at companies with names that began with the letters A or B. That inevitably eliminated most net nets from contention. In my own experience, there are a lot of net net stocks available for smart investors willing to invest internationally. I send many of these stocks out to those who requested free net net stock ideas.

The second takeaway is that both quality and price have a major impact on returns. Looking at the results, when holding PE requirements constant, the cheaper portfolios in terms of price to NCAV outperformed the more expensive portfolioes. Likewise, when holding price to NCAV requirements constant, the portfolios that demanded more earnings for the price paid outperformed their peers. By combining both value and quality, as Greenblatt did in portfolio #4, an investor can do very well in the stock market.

Finally, it's fairly clear that Joel Greenblatt's original Magic Formula, and NCAV stocks in general, trumps Greenblatt's contemporary Magic Formula. Sure, the Magic Formula that Greenblatt champions in his latest book is a good investment strategy, on the whole, but it just doesn't live up to his forgotten original Magic Formula. While his contemporary Magic Formula was reported to return just north of 23% per year vs. the S&P 500's 9.6% return, Greenblatt's original Magic Formula spanked that return -- and did so during a flat market, as well!

 How I'm Leveraging Greenblatt's Original Magic Formula

As you can see, Greenblatt's original Magic Formula is magical indeed.

His study has had a huge impact on my own selection criteria. When selecting net net stocks, I look for firms that have a deep discount to NCAV but still focus on high quality situations. For example, I currently own two deeply discounted stocks based on NCAV and earnings: one trading at just over 5x earnings and just over 40% of NCAV; the other offering a PE of 6 and trading at 68% of NCAV. Joel Greenblatt would be proud.

The biggest challenge to earning 25-35% annual returns is not the actual investing -- it's finding the investment opportunities. Right now Net Net Hunter members have access to over 450 net net stocks in 5 countries, as well as Shortlists of the best possible net net stock opportunities in each country. Make the most of your time by quickly finding the best net net stocks available.

http://www.netnethunter.com/joel-greenblatt-original-magic-formula/

Joel Greenblatt’s Original Magic Formula (NCAV)

Most investors are familiar with Joel Greenblatt’s Magic Formula, made famous in his book, “The Little Book That Beats the Market”.

The key drivers of the Magic Formula we know today are Earnings Yield (EBIT / Enterprise Value) and Return on Capital (EBIT / (Net Fixed Assets + Working Capital)). Companies are ranked according to these two metrics — highest earnings yield and highest return on capital — then the 20 to 30 companies with the highest ranks are purchased at a rate of two to three positions per month over a 12-month period.

However, before Greenblatt came up with this quality-and-value screen, he built a strategy around Benjamin Graham’s net-nets strategy, which relatively unheard of and has since become known as Greenblatt’s Original Magic Formula.

Greenblatt’s original Magic Formula

Greenblatt developed his Original Magic Formula with Richard Pzena, who currently manages Pzena Investment Management LLC, a value oriented global investment management firm with $28 billion in assets under management, and Bruce L. Newberg. The three money managers published their findings within the The Journal of Portfolio Management Summer issue 1981, Vol. 7, No.4, in an article entitled, “How the Small Investor Can Beat the Market: By Buying Stocks That Are Selling Below Their Liquidation Value”

Greenblatt and his co-authors argued within the article that only way the small investor can beat the market, is by looking for undervalued stocks. To do this successfully, the investor has to look outside the realm of Wall Street’s analyst coverage:

“We should recall, however, that Wall Street research houses limit their coverage to fewer than 500 actively traded issues…Meanwhile the NYSE trades 2000 stocks, Amex trades 1000 companies, and the OTC market trades another 7000 issues…Under these circumstances, the individual may in fact be able to locate unrecognised values in the nearly 9000-stock second tier not closely followed by the “experts”.

The figures are different today, but the underlying argument remains the same. Greenblatt built up his deep value strategy from there:

“In an effort to discover whether inefficiently priced, undervalued securities do exist, we turned to the acknowledged father of security analysis, the late Benjamin Graham…decided to update Graham’s studies to see if his simple fundamental approach still provided the returns that could not be explained by an efficient market.”

To start, Greenblatt used Graham’s traditional net-nets formula to screen for bargains:

Current Assets – Current Liabilities – Long Term Liabilities – Preferred Stock / Number of Shares Outstanding = NCAV Per Share

After using this formula to build a rough list of qualifying NCAV stocks, Greenblatt went further, in an attempt to remove any ‘junk’ firms from the list — something that’s been a thorn in the side of the deep value investors ever since the strategy was first conceived. To try and remove the wheat from the chaff as it were, Greenblatt enlisted the help of the P/E ratio.

Separating out the chaff

Benjamin Graham’s last will was a set of ten rules used for stock selection based on Graham/s five decades of stock market experience. The list of ten points, published around the time of Graham’s death, will be familiar to most value investors:

1. An earnings-to-price yield at least twice the AAA bond rate
2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years
3. Dividend yield of at least 2/3 the AAA bond yield
4. Stock price below 2/3 of tangible book value per share
5. Stock price below 2/3 of Net Current Asset Value
6. Total debt less than book value
7. Current ratio greater than 2
8. Total debt less than 2 times Net Current Asset Value
9. Earnings growth of prior 10 years at least at a 7% annual compound rate
10. Stability of growth of earnings in that no more than 2 declines of 5% or more in year-end earnings in the prior ten years are permissible.

There’s no denying that this list of rules is extremely onerous and in most markets the number of stocks that meet all ten criteria is likely to be minimal. (Société Générale publishes a monthly stock screen based on the Graham criteria —the April update can be found here — the bank’s analysts note that in the past two decades, only three companies have passed all ten criteria out of a universe of FTSE World Developed, FTSE 350 stocks and FTSE World Emerging stocks.)

When Joel Greenblatt set out to create his new NCAV strategy he clearly wanted it to be less restrictive than Graham’s criteria. However, Greenblatt also wanted his new deep value strategy to outperform, with less risk than the wider market.

To accomplish these goals, Graham’s list and put together and added the P/E ratio to his NCAV screening criteria. Greenblatt tested four different four portfolios, each with a different P/E screening criteria.

Portfolio one

• Price below NCAV
• P/E floating with corporate bond yields
• No dividends required

Portfolio two

• Price below 85% of NCAV
• P/E floating with corporate bond yields
• No dividends required

Portfolio three

• Price below NCAV
• P/E of less than 5
• No dividends require

Portfolio four

• Price below 85% of NCAV
• P/E of less than 5
• No dividends required

Stocks with a market cap of less than $3 million were discarded from the study. Stocks were sold after a 100% gain or two years had passed, whichever resulted first. The portfolios themselves were equally weighted, so the actual yearly returns of each portfolio were just the average returns of the stocks within each portfolio. The returns of the four portfolios were compared to the Value Line’s own value index.

The results show that portfolios three and four, which demanded qualifying stocks trade at a P/E of less than five, racked up the best performances of the group.

The average performance of portfolio three was 32.2% p.a. per annum excluding tax and commissions — the high portfolio turnover meant that returns were impacted significantly when including commissions (12.1% p.a. after including taxes and commissions).

Portfolio four returned 42.2% p.a., although this dropped to 29.2% p.a. after excluding taxes and commissions. Interestingly, these two portfolios performed better than Greenblatt’s second Magic Formula, which boasts of 30% p.a. returns.

http://www.valuewalk.com/2015/04/original-magic-formula/

Meredith Whitney Says She's Done With Hedge Funds After Struggle

By Max Abelson


Meredith Whitney, who turned fame as a banking analyst into a stint running her own hedge fund, is through with managing other people’s money.

“I think that chapter of my life is over,” she said in an interview with Fox Business on Wednesday. “This whole experience has been highly unfortunate and I’m putting it behind me.”

Whitney’s prescient warning before the financial crisis that Citigroup Inc. would cut its dividend turned her into a Wall Street star and put her on magazine covers. Her firm Kenbelle Capital and its American Revival Fund started investing in heartland stocks in November 2013, after she predicted on TV and in a book that the center of the U.S. would boom.

More from Bloomberg.com: A $3 Trillion Traffic Jam Is Seen Looming in Credit by Citigroup

Her top investor, a fund tied to billionaire Michael Platt’s BlueCrest Capital Management, sued in December to get back its $46 million after months of losses. A court filing this month showed the two had resolved the claims. Whitney didn’t immediately respond to messages left at her office.

In a brief phone call Wednesday, Stanley Arkin, a lawyer for Whitney, wouldn’t elaborate on her interview.

“She’s an honest woman,” he said. “I’m not at liberty to say anything more than that.”

Starting her debut fund without a staff of analysts to help choose investments and relying too much on one investor’s money helped lead her astray, a person with direct knowledge of her firm told Bloomberg earlier this year, after her New York office went on the market and top executives left.


“At the end of May I returned money to every single investor,” she said in the Fox interview. Whitney is now focused on analyzing financial stocks, including the company that made her famous. “Citi’s interesting,” she said.


http://finance.yahoo.com/news/meredith-whitney-says-shes-done-171526255.html