  |
|
The Sleuth
In his 155-page sure-to-be-a-classic, the Gotham Capital founder unveiled his “magic formula” that consistently beats the market. According to Greenblatt, if you’d simply invested in a basket of about 30 stocks with the highest combined earnings yield and return on invested capital (yes, that’s his entire magic formula), you would have averaged a 30.8% return between 1988-2004. During that same stretch, the S&P 500 averaged only a 12.4% return. His magic formula outpaced the market by a nearly 3-to-1 margin for 17 years. Amazing! ************************************ Don’t Be Blindsided by the Greatest Economic Collapse in U.S. History The world’s greatest living economist -- the man who accurately predicted the Asian currency crisis of the ’90s, the collapse of the Brazilian real in 1998 and the dot-com bubble of 2000 -- says we are about to see three events that will lead to the worst economic disaster in U.S. history. When it’s all said and done, your home, 401(k) and entire portfolio will be in jeopardy. But there is one thing you can do to protect yourself. Read about how you can get free admission for one year to the world's most unique and intelligent circle of potential investors right now... ************************************ But the real question everyone in the financial media is asking is can these results be replicated going forward? In other words, if you use Greenblatt’s magic formula to invest for yourself, can you expect to outpace the market by a 3-to-1 margin? (If you aren’t familiar with how the magic formula works, please check out this white paper I’ve prepared on Greenblatt’s findings... Last week, Barron’s published an article by Bill Alpert titled “The Little Book’s Little Flaw.” Mr. Alpert pointed out five potential reasons why it may be folly to expect to triple the market for the next 17 years: 1) Greenblatt’s results were back-tested. He didn’t actually make 30.8% a year in real life. He used a very expensive database (Compustat) to test -- or simulate -- his formula using data from years past. As a result, his test didn’t take into consideration things like commissions and potential liquidity issues -- which we small-cap investors have to deal with each and every time we buy and sell. 2) The results aren’t 100% replicable. Several well-known financial analysts have tried to test the magic formula on databases other than Compustat. In each case, the results were slightly less than Greenblatt’s. Barron’s back-tested the formula from 1997-2002 (on a large-cap portfolio) using Bloomberg’s database and found the average annual gain to be 10%, versus Greenblatt’s 16%. ClariFi -- a financial firm in Boca Raton, Fla. -- also tried to replicate Greenblatt’s formula. It back-tested the results on the top 3,500 largest stocks from 1988-2004, just as Greenblatt did. Instead of averaging a 30.8% return, it managed “only” a 28% annual gain. 3) Greenblatt’s study was done in the biggest bull market in U.S. history. So if the market ever fell, his results could be substantially less. 4) Although Greenblatt tells you the basic components of his magic formula (high earnings yield and a high return on invested capital), he doesn’t tell you exactly what the formula is. For instance, Alpert astutely points out that “When he calculates return on capital, for example, Greenblatt only counts cash in excess of what’s needed to run the business.” Who the heck can figure out what Greenblatt considers to be “in excess”? 5) There simply isn’t enough data to know if his magic formula really is magical. For example, how would it have worked in the 1950s? What about the 1920s? Or maybe the 1960s? All five of these gripes are legitimate. Greenblatt’s formula isn’t perfect. The Gotham Capital founder certainly left some details for us to figure out for ourselves. But that’s OK. The logic behind his formula makes perfect sense. By screening stocks with high earnings yields and return on invested capital, you are essentially looking for companies that are cheap and that use capital wisely (with the shareholder in mind). Over time, those are exactly the kinds of companies that should -- and, in fact, do -- outpace the rest of the market. And whether you earn 10%, 16%, 28% or 30% a year, who cares? Over the last five years, the Nasdaq is up only 4.9% a year and the S&P 500 is up a meager 2.3% a year. ************************************ 5 New Ways to Get Rich In the Gold Market We’re so sure gold will soar higher, we’ll even guarantee it lands at least 257% above where it is right now... Learn all about a way to buy gold for as little as one-tenth what other bullion investors will pay... while making as much as 12 times what they'll make on every move upward in the gold price... Read the special report RIGHT NOW... ************************************ Basically, the magic formula should help you beat the market -- the only question is, by how much? Of course, if you choose to invest in companies that fit Greenblatt’s magic formula, don’t expect a smooth ride. In fact, you better have some Maalox ready and a good seat belt to strap yourself in. It can be bumpy at times. Essentially, Greenblatt’s formula screens for beaten-down companies that have experienced a major decline in price for one reason or another. As a result, they are cheap and tend to be out of favor. And out-of-favor stocks don’t rise just because you buy them or they are indeed undervalued. Case in point... I recommended my Penny Stock Fortunes readers buy shares of Forward Industries (FORD:NASDAQ) back in January for under $11.25 a share. Forward makes cell phone cases for some of the major manufacturers -- including Motorola. It had an earnings yield of 21.5% and a return on invested capital of 166% -- making it one of the 100 best stocks to own according to Greenblatt’s formula. Unfortunately, shortly after I recommended the stock, it dropped like a stone -- falling 26% in almost no time. The reason? 2005 was a breakthrough year for Forward. Earnings rose twofold. Sales increased 158%. And its stock was one of the hottest on Wall Street -- rising 597% from January to September. But no company can maintain that furious growth, Forward included. And that became obvious when it announced Q1 earnings for FY 2006 that were less than its results a year ago. On that “bad” news, people sold off like the company was going out of business. Needless to say, I wasn’t thrilled with the falloff. So I reread the company’s annual and quarterly reports to make sure I didn’t miss something. I didn’t. I saw NO reason Forward stock deserved to be so cheap. It was still very profitable. Its profit margins were two times better than its peers’. It had a pristine balance sheet with tons of cash and almost no debt. And despite “missing” its earnings target, it still recorded one of its best quarters in company history. Yet it was no longer the growth stock it once was. So Wall Street wanted out. At one point, Forward was down 26% from my entry price. Still, I told my readers to hold. There was nothing fundamentally wrong with this company. Over time, it would rise again. The key was to be patient. Turns out you didn’t have to be patient for too long. Last week, shares rose from $8 to over $11 in six trading days. And today, Forward is back in the black for my readers. Once down 26%, it is now making money. My guess is that FORD will hit $15 or $16 before the end of the year -- especially with Nokia coming out this morning saying it expects the cell phone market to rise 15% in 2006. If that happens, anyone who took my advice is looking at a nice gain of between 36-45%. But only time will tell. Forward Industries is a perfect example of the kind of company you can expect to find if you use the magic formula on your own. It is cheap and clean and has potential to grow. Those are all good qualities to have in any investment. Sure, there are some flaws with Greenblatt’s magic formula. It may not outpace the market threefold over the next 17 years. But if it finds companies like Forward, I’m a happy man. I have no problem making “only” 36% on my investments. And I have a feeling you don’t either. So let Wall Street poke at the magic formula all they want. We’ll keep using it to find beaten-down stocks that no one wants. Here’s to good investing, James P.S. To get a list of Greenblatt’s top picks right now, you can visit his free Website at http://www.magicformulainvesting.com. It’s a great tool for any serious investor. Check it out. Don’t let this opportunity pass you by -- read about all 12 of these amazing companies in this special report right now... |
|
|
James Boric is the editor-in-chief of Penny Stock Fortunes and has developed the lucrative CXS System -- which constantly scours the market for fundamentally sound small-cap companies with tons of growth potential... <click here for full bio> |
|
