The Magic Hat portfolio on Stockopedia
(http://www.stockopedia.com/fantasy-funds/magic-hat-463/) is an experiment by me to see if a human can improve on a mechanical Greeblatt Magic Formula screen. I am trying to weed out “mistakes” that I feel the screening commits: unseasoned companies, scams, foreign companies (particularly Chinese), fishy accounting, and statistical quirks. Apart from that, I am agnostic as to the sector the company operates in, although I will try to avoid heavy concentration in any one sector. I will mostly apply “Strategic Ignorance”, by which I mean that I wont try to be clever in my stockpicking. My picking will be mostly mechanical.
I have been transitioning my Stockopedia Fantasy Fund from a defensive fund to a Magic Formula fund since late last year. It is interesting to compare how the Greenblatt screen
(http://www.stockopedia.com/screens/greenblatts-magic-formula-1/) is comparing to my Magic Hat screen over the last 6 months. So far, the results are encouraging. Magic Hat is down 0.4%, against a considerable slide of 14.6% from the Greenblatt screen. Both are trailing the Footsie over that period, though. In late February, the Greenblatt screen was up 44%, substantially ahead of the Footsie, which was up 26%. The fund was started in December 2011, so investors in the Greenblatt screen would have noted significant outperformance. Unfortunately, that outperformance has eroded, so that, overall, the fund is underperforming the Footsie. The moral of the story is that under- and over- performance statistics can often be heavily influenced by the choice of start and end dates. Additionally, one must be careful of buying into a strategy when it is proving too powerful. Trends will often revert.
Having said that, the Greenblatt fund now has a median EY (Earnings Yield) of 18%. Only two companies in the fund have EYs less that 10%. That suggests to me that there is good value to be had in the market, and reason to be optimistic that the medium-term return will be good. Nothing is ever that straightforward, of course. The Ukraine situation seems to be kicking off again, and could well fuel more downward pressure in a market that many perceive as toppy.
Still, the fund invests based on perceived value, not market timing concerns.
The Magic Hat portfolio itself has had a somewhat mixed performance. It is beating the FTSE350 by about 3% over 1 year; hardly anything to get excited about. It is actually slightly underperforming that index over 2 years, and is ahead by about 7% over 3 years. That is hardly earth-shattering. The outperformance is more impressive if you look at the fund since inception.
For August, NPT (Netplay TV) goes into the Magic Hat Fund. Nothing was ejected, on account of there existing enough cash in the fund to buy a monthly share. NPT provides interactive casino services, including Supercasino.com and Jackpot247.com. The shares have been battered lately over fears of the proposed PoC (Point of Consumption) tax, as well as growth not living up to investor expectations. The fear is that the PoC tax will decimate company profitability; although the company has itself claimed that it has taken steps to mitigate much of the potential damage. The legality of the tax has also been disputed, so it is an open question as to what, if any, the impact a PoC tax will be. The shares reached a 52w high of 24p in January, and now stand at 12.125p. Clearly, there has been a big change in sentiment towards the company. The shares have a 14d RSI of 11%, making them extremely oversold. The shares have a Stockopedia Value rank of 94, and EV/EBITDA of 4.4, and a price to free cashflow of 6.6. It could be that those cashflows take a substantial hit. Nevertheless, it’s still cheap.
Here are two things that I think are important criteria for selecting Greenblatt-esque shares:
* look for an earnings yield of at least 10%. I have seen many shares that are marginal on this valuation. Inevitably, you buy into them, and something doesn’t go quite right. You then get clobbered. This happened to me when I put HNT (Huntsworth) into the Fund – mere days before an RNS came out that smashed the share price further. You really want to try to buy when the shares are despised and everyone regrets having purchased them, rather than being considered merely “good value”.
* look for signs that the company is oversold – which I define as the (14d) RSI being less than 30%. That is the typical definition of oversold. I think it is OK if, alternatively, you buy shares that have just recently emerged from being oversold. It seems as though you can get a much clearer run at positive momentum. Whereas, if you buy when you are in oversold territory, you often don’t know where the bottom is, and tend to buy too early.
There are no guarantees to any of this. A company could
recover from being oversold, but its fundamentals can deteriorate further. The seemingly low valuation and poor sentiment can turn out to be illusory. But you run a lot of risks by buying into overbought territory. The market is fickle at the moment, directionless, and it is punishing both value and story stocks. If the shorter-term traders become bored with a stock, then you can expect to be hurt as they exit their trades.
I should also point out that my track record with gaming stocks is atrocious. Despite that, NPT is in at 12.25p.
One last thing. I am now keeping a highly-condensed summary of the Magic Hat articles at the following web page:
http://www.markcarter.me.uk/money/greenblatt.htm This will allow you to tell, at a glance what shares have been bought and sold in the past, as well as what shares have been rejected from consideration and why. Shortly, I will start tracking the median Earnings Yield of the Greenblatt screen. This should provide some kind of guide as to whether or not its shares are attractive.