Zecco After 2 Months; 3 Magic Formula Picks

Here are 3 Magic Formula picks that might be worth investigating. I probably won't be making any more transactions this year, since I've got 7 Magic Formula positions (FCX, FDG, PALM, PLAY, OVTI, PWEI, EGY). I'm glad I avoided Addudell (looking at the company's history, they seem to completely change their focus to match whatever the hot sector is at the time). I wish I had bought some PNCL (up 29% since 11/6). PLAY was a big winner, with the buyout, and FDG has almost recovered from the big sell-off after the talk of Canada changing its tax treatment of trusts.

Also, Zecco does pay interest on deposited funds, for anyone wondering about that. The yield on the money market fund was 4.35% last month, competitive with my ING account, but not FDIC insured. Zecco is not the place to store your cash, it's a place to buy stocks with zero commissions.

Now, on to the Magic Formula recommendations:

• Biovail (BVF) develops different formulations for drugs for better effectiveness. It's currently $20.45/share, with an Earnings Yield of 15% and Return on Capital over 100%.
  
  Despite the expected January 2007 launch of a generic version of Wellbutrin, Biovail's top product, the company has forecast earnings for 2007 of $1.75/share, above Wall Street's estimates. They announced plans to eliminate their U.S. salesforce, retire debt, and increase research spending, as well as triple their dividend (to $1.50 a share) and pay a special $0.50 dividend in January. That's definitely intriguing to me, a big fan of dividends.
  
  
  
• CCA Industries (CAW) is in the business of health and beauty, with a variety of products (such as Plus+White and Nutra Nail) sold at drug stores and other places. It's currently $11.72/share, with a 14% EY and +100% ROC. The market cap is only $82 million.
  
  
  
• EPIQ Systems (EPIQ) is a software and services company that specializes in legal matters, and stands to benefit from any increase in bankruptcies. $17.02 is the current share price. It has a 16% EY and +100% ROC, with a market cap of $331 million.
  
  

Performance of Recommended Stocks

Here is a Google spreadsheet that lists the stocks recommended by the Magic Formula, and each one's performance since it was mentioned here.

November Portfolio Results

I didn't get a screenshot of my Zecco portfolio from the end of November, but I must admit that I have been so pleased with Zecco and its 0$ commissions so far, that I've started using it for my non-Magic Formula investments, as well.

November was a bad month for Fording Canadian Coal Trust (FDG), with the proposal for changes in Canadian tax law causing a significant drop.

I've created a
Google spreadsheet, showing the portfolio and comparison to the major indices

The results are not too impressive, but I expect that to change over the next year.

I'll make another spreadsheet showing all of the stocks I've highlighted from the Magic Formula lists, and what sort of returns they achieved since the date I mentioned them.

United Online

• United Online (UNTD) is the company that now includes NetZero and Juno, and is currently $13.70/share. It has an 11% pre-tax earnings yield and has recently announced that DSL internet service will now be available. It pays a dividend, with a yield of almost 6% currently. It may be worth a look.
  

Two Commodities Plays, and Two Troubled Companies

• Vaalco Energy (EGY) is an oil and natural gas company that has been on an amazing run the past few years. The stock could be worth two times its current price if it keeps growing like this, and looks to be the best prospect on the list.
  
  
  
• Expect Freeport-McMoran to take a hit today on news that it is taking on debt to acquire Phelps-Dodge at a significant premium.
  
  Two Troubled Companies
  
• Merge Technologies (MRGE) is a medical imaging company that has recently announced plans to cut 28% of its American and Canadian workforce and move those jobs to India. Will this be enough to make them profitable again?
  
  
• Optimal Group (OPMR), a payment processing company adversely affected by the recent gambling legislation.
  
  

Value Investing Video

Joel Greenblatt, author of The The Little Book That Beats the Market, teaches a class on Value and Special Situation Investing at Columbia University. A video from November 3rd is available on the class website. This video is just over 2 hours long. The first half is about Moody's, but the second half is about The The Little Book and the studies and principles behind it. He explains why a fund manager would be unable to successfully follow the magic formula, because any lengthy period of underperformance, relative to his benchmark, would get him fired. Investors don't want to underperform the market for a couple of years or more, even if they will soundly beat the market over longer periods of time. The focus on short-term performance gives an opportunity for what he calls "time arbitrage" to those with the patience to stick with their investment strategy (buying great companies at bargain prices) until it pays off.

Two New Companies Make the List

Two new companies have entered the Magic Formula top 25 this week, but they both seem to be weak contenders to me:

1. Nathan's Famous (NATH) - Famous for the hotdog-eating contest held every year on Long Island, this doesn't look like the most compelling investment on the magic formula list, with its 12% earnings yield. If you take out one-time items from selling property last year, earnings are up, at least. The current focus seems to be on licensing and franchise fees. Last week's earnings report dropped the stock about $1.50 a share, down to $13.05.
   
   
2. New Frontier Media Inc (NOOF) is the other new entry. It's an adult entertainment company, that distributes its product via pay-per-view, hotels, cable, video on demand, and wireless. It's announced a "major victory over Playboy (PLA)". It has an earnings yield of 11%, and the management doesn't seem to be the most honest.
   
   

Three Promising Prospects

These three companies showed up on my latest check at the Magic Formula website:

• PW Eagle Industries (PWEI) - This company makes PVC pipe and PE tubing, used in irrigation, plumbing, natural gas pipelines, and telecommunications, throughout North America. It is significantly undervalued at $36.16/share (with an earnings yield of 37%). I'm adding this company to replace PLAY, which is being bought out by NVidia.
  
  These next two are not quite the bargain that PWEI is:
  
• Western Refining (WNR) operates in the Southwest. Its next earnings release is on November 13th, and it has an 18% earnings yield. Current price is $25.04
  
  
• Frontier Oil (FTO) - Another refiner, Frontier has two refineries, in Wyoming and Kansas. It specializes in heavy sour crude (as opposed to light sweet crude). This type of oil is more expensive to refine, and cheaper to buy. The spread between light sweet and heavy sour has been especially pronounced lately, leading to more profits for FTO. It, too, has an 18% earnings yield, and is currently $30.71/share. The company has over $3/share in cash, to help it weather any difficulties.
  
  

NVidia Buys PortalPlayer, Palm Gets Sued

It's a good news, bad news day.


PortalPlayer (PLAY) is being bought out for $13.50/share by NVidia, a 23% gain in less than two weeks.


Meanwhile, Palm is now getting the same treatment from NTP as Research in Motion, who paid out over $600 million in ransom to the patent holding company. The stock dropped, but that's no reason to bail. It's possible that Palm will settle the matter quickly, instead of letting it drag out for years. It's also a possible takeover target.


PLAY will need to be replaced in the lineup, most likely by one of the companies I listed yesterday, like ADDL.

Five Companies that Fit the Formula

Here are 5 companies that fit the magic formula of high earnings yield and return on capital. Being undervalued, relative to earnings, good news has a greater effect than it would with a company that is already priced for perfection.

1. PNCL (Pinnacle Airlines)
   At $8.29/share and with over $2/share of earnings predicted for the year, this regional airline, a subsidiary of Northwest Airlines, has a chance for a good 'pop' when it announces earnings this Tuesday, November 7th.
   
   
2. ADDL (Aduddell Industries)
   At $1/share, this roofing and restoration company barely makes the $50 million market cap criteria. It reported a profit in the quarter ended June 30, as opposed to a loss last year, and on October 24, estimated $75 million in revenues for the year. It is planning growth through acquisitions in this fractious industry with no major players.
   
   
3. ASPV (Aspreva Pharmaceuticals)
   This pharmaceutical company works on marketing and developing new indications for existing drugs, and is currently partnered with Roche on CellCept, an anti-rejection drug for heart, kidney, and liver transplants. The stock has taken a hit with the announcement, last week, that CellCept failed in its Phase III trial for myasthenia gravis treatment. Other trials are ongoing, for research on the treatment of lupus and pemphigus vulgaris. The risk with this company is that they won't be able to partner with another company on any other drugs. CellCept will begin facing generic competition in 2009.
   
   
4. FCX (Freeport-McMoran) This mining company owns a mine in Indonesia, and that's basically it. It's a great mine (the largest gold reserve in the world, and the second-largest copper reserve), but the possibility of political turmoil in this country makes it a risky investment. It has a nice dividend yield of 2% to go along with the possibility of price appreciation.
   
   
5. OVTI (Omnivision)
   Omnivision makes semiconductor image sensors for use in cameras, and has recently introduced a chip designed especially for use in automobiles. It can be used for assisted parking, backing up, driver drowsiness detection, airbag deployment, drifting into another lane, and detection of pedestrians and other vehicles. These applications are expected to become more and more available in new cars in the future. There are also possibilities for OVTI in the medical field. The company has a lot of cash (around$3.44/share), no debt, and a history of innovation, but is in a competitive field. OVTI is heavily shorted, so there is the possibility of a short squeeze down the road.
   
   

Disclosure: I own stock in both Freeport-McMoran and Omnivision.

The Terrible Truth About Investing

The Terrible Truth About Investing: How to Be a Savvy Investor, by Bruce J. Temkin, published in 1999, during the tech bubble, should be in every investor's collection. I turn to it often for insight. It's a short book, and very accessible, full of useful charts and examples.

One thing it covers is inflation ("the silent killer"). Temkin says the only good thing about inflation is that "a kid can't get sick on a nickel's worth of candy anymore". Taxes blazenly rob you of your return, forcing to you write out a check at gunpoint once a year, but inflation does it quietly, while you're sleeping, every night.

The book is filled with charts, showing you that what you think is a great return may not even be keeping up with inflation (historically, T-Bills have been an investment that returns 0.6% after inflation, while there have been 4 20-year periods where investing in stocks returned 2% after inflation, like 1961-1981). Others demonstrate, in dollar terms, what it is like to go through years of losing money, like the 1970's, when people gave up on the stock market entirely.

He points out that, while diversification can reduce volatility and risk (the often pointed out benefits), it can also result in lower returns than if you put it all on a single stock. You should know what to expect.

He talks about temperament in investing. Some people are unwilling to even contemplate some scenarios that are likely to occur (because they have occurred before)--they are just too terrible to contemplate. What people say and what they end up doing are two different things. People tend to buy high and sell low, which is not the preferred method.

For retirement, he recommends examining the assumptions behind your software or calculator (I think they usually underestimate inflation and overestimate rate of return for stocks). You should run "monte carlo" simulations, plugging in different numbers to get a range of results, to determine a set of possible outcomes and see if you're saving enough for retirement.

The book is out of print, but at this time, 7 sellers have it listed at Amazon (I am not one of them, sorry!):

October Portfolio Results

Here's what my portfolio looks like at the end of October (stocks were purchased on the morning of 10/26, during a substantial dip):



At this time, there's a 3.67% return.


A few relevant indices for comparison:

Index        Symbol     10/26       10/31      % Change
DJIA         ^DJI      12,100      12,080      -0.17%
S&P 500      ^GSPC      1,380       1,378      -0.15%
Nadaq        ^IXIC      2,350       2,365       0.64%
Wilshire 5k  ^DWC      13,834      13,829      -0.04%

So, so far, so good, but it hasn't been a week yet. The Magic Formula method calls for holding these stocks for about a year (sell early if you have a loss, and hold the winners over one year for the long-term capital gains tax rate, instead of the marginal tax rate).

I'm feeling confident now, but value investing often puts the investor at odds with the herd (you're often buying a stock everybody else hates), and it often gets pretty lonely out there.

The Other "Little Book"

Morningstar.com has an article about that other "little book", Christopher Browne's 'Little Book of Value Investing'.

Chrisopher Browne is a managing director of Tweedy Browne Company, LLC, a company associated with Ben Graham and Warren Buffett.

He recommends avoiding companies saddled with debt, and buying companies with a high earnings yield (should sound familiar to anyone following the Magic Formula), low price/book, with insider purchases. And like Greenblatt, he knows that few people will be able to follow his advice, because they lack the temperament (Greenblatt says patience). The article links to an excerpt from the book, and another useful article on moats and investor temperament.




Tomorrow evening, I'll post my results so far. I plan on posting a portfolio update every month.

Where Is The Yield?

Where Is The Yield? is another blog here at blogspot about investing. This article is entitled, Highest-Yielding Magic Formula Stocks. The author has tweaked the magic formula to go for dividend-paying companies that also fit the magic formula (high return on assets, at a bargain price). I prefer dividend-payers, myself, because it means they are profitable. His method makes sense to me.

First Transactions at Zecco.com

Thursday, 10/26, I made my first 5 trades as part of the Magic Formula. Here are the steps I took:

1. Went to MagicFormulaInvesting.com and requested a list of 25 companies with market capitalizations above 50 million.
   
2. Picked 9 companies, looking for either recent filings or good return numbers, or a name I recognized. The formula calls for choosing 5-7 of these companies at random, and I strayed a little bit from this. The time I spent researching these companies was a couple minutes each. I read their company profiles, saw if they pay a dividend, and that's about it.
   
3. Did a sanity check on these to see if they were profitable, and ran a generic DCF analysis to see if they were undervalued, based on analyst projections (one of the points of the magic formula is that nobody knows how much a company will grow in the future, but you can see how much money they made in the past; this is obvious when you compare high and low analyst projections for most companies. Trained professionals vary widely in their guesstimates, so why should I, an average guy with no training, spend hours and hours trying to come up with my own numbers?). This bumped off just 1 company, and 1 company squeaked by, so I dropped it.
   
4. Left with just 7 companies, I dropped 2 more. I had looked into buying one earlier this year and had rejected it (it was a biotech with 1 product about to face generic competition, Viropharma), so I marked it off the list, and dropped the other because I didn't like its product. Maybe I'll buy these 4 dropped companies in a couple of months.
   
5. Bought equal dollar amounts (or about as close as I could get) of the following 5 companies at Zecco.com:
   

1. 9 shares of FCX @$59.31 = $533.79
   
2. 20 shares of FDG @$24.72 = $494.40
   
3. 33 shares of PALM @$15.41 = $508.53
   
4. 46 shares of PLAY @$10.94 = $503.24
   
5. 29 shares of OVTI @$15.78 = $457.62
   For a grand total of: $2497.58
   

The plan is to do this every 2 or 3 months, and post the results.

What is Zecco? and Why Zecco?

It's not some kind of candy, it's a website offering commission-free trades, relying on interest on deposits and ad revenue to cover the $2/trade cost, and relying on news stories and word of mouth to gain customers. There are some limitations, however, like only 10 trades in one day, or 40 in a month ($3.50 for each trade above that).

Why choose Zecco for magic formula investing? First, let's review the magic formula itself. It requires you to buy 5-7 stocks every 2 or 3 months, and sell them about a year after purchase (sell losses before the year is up, and gains after a year, for tax purposes). This gives you 60 buys and sells in one cycle. When you sell, you're also going to be buying the same number of stocks to replace the ones you sold, so once you get started, you have months with 10-14 transactions occurring every 2-3 months.

Running the numbers with Sharebuilder, you can buy 6 stocks in a month for $12, with the standard subscription, which isn't too bad. But to sell those 6 stocks a year later will cost you $14.95/each, or $89.70. If you time your purchases to 5 months with 6 buys per month, you'll incur $12 X 5 = $60 for the purchases, and 30 X $14.95 = $448.50 for the sales, for a grand total of $508.50. I don't know about you, but that isn't an inconsequential amount of money for me. Foliofn and other similar sites will cost similar amounts, due to the monthly fees.

What about Tradeking, with $4.95 trades? That will still run you almost $300 for 60 trades, or $50-$70 every 2-3 months. It's hard to beat free.

What is Magic Formula Investing?

Magic Formula Investing is a value investing method that is pretty simple, and outperforms most anything else. It looks at companies that generate a good return on investment, and buys them when they're on sale. If you go to MagicFormulaInvesting.com, you can even get the list of companies to buy stock in, for free! Sounds pretty simple, right? We'll see...

The Magic Formula is explained in Joel Greenblatt's Little Book:

Account set up and funding with Zecco

To set up my Zecco.com account, I needed the usual account setup type things, like bank account information, social security number, etc. I also had to send the signed paperwork with a photocopy of my driver's license, but could expedite the process by scanning and emailing this. To verify my ING Direct account, they made 2 small deposits. One warning: once I confirmed the account, they withdrew these deposits. So you may want to be careful with accounts that only allow 6 withdrawals per month. It will take 3 withdrawals to confirm and fund your account.

Timeline:
10/09 - Set up online account with Zecco.com (for accessing the site, message boards, etc.)
10/13 - Applied for an account online
10/17 - Emailed paperwork
10/18 - Received a reply, reminding me to mail the physical documents
10/20 - Account application approved. signed in and created 'trading key', began process to have ACH link with ING confirmed.
10/21 - Mailed physical documents
10/24 - Received 2 small deposits and confirmed bank account, initiated withdrawal of $2500 from Zecco's site
10/25 - Money withdrawn from ING
10/26 - Money available for trading