Magic Hat Portfolio January 2015: KAZ+INDV in, DGO out

I was too disinterested to do a share pick for the Magic Hat portfolio last month, and was about to just leave it for this month/year, but then decided “what the hey”.

The portfolio has returned 0% over a 1 year period, so I’m not expecting calls from hedge funds eager to invest in my picks any time soon. Still, the portfolio did beat its benchmark, the FSTE350, over the same period, which returned -4.0%. It absolutely smashed the Greenblatt screen, from which the stocks were selected, which returned -15.7%. By rights, this shouldn’t have been possible, as evidence suggests that robotic strategies outperform humans.

I am in the process of reading Deep Value by Tobias Carlisle lately. I highly recommend it. It’s very readable, and the author, and he explains what works and what doesn’t, without turning it into a book of statistics. He has a one-hour talk at YouTube, which I recommend that you listen to: http://youtu.be/1r1vJZ80Z7I

It addresses a lot of concerns, and confirms, some of my suspicions about the Magic Formula. There is a growing body of evidence that suggests that metrics of cheapness alone outperform cheapness combined with goodness.

Statistically, returns on capital tend to revert for all but a small portion of companies.

With that idea in mind, and given that it’s a new year, I’ve decided to change the focus of my strategy. Instead of being “cheap and good”, I’ll concentrate on “cheap and nasty”. I want to buy 2 stocks a month, the spread the risks, and hopefully capture any of the stocks that go on to surprise. It’s a portfolio strategy, rather than relying on investing skill.

What “should” be booted out of the portfolio are DTG (Dart) and REDD (Redde), due their age, but I have decided to keep them in because they have good momentum. I’m a sucker for a bit of momentum. Instead, I’ve elected to eject DGO (Dragon Oil) from the portfolio, as I’m having trouble believing that their margins are real. The stock itself passes 12 long screens and 2 short screens on Stockopedia. The short screens are: earnings downgrade and “Cooking the Books”. I’m not keep on the idea of companies cooking the books.

To decide what companies to include, I use Stockopedia to rank for EV/EBITDA. It would be nice if Stockopedia had an EV/EBITDA screen [see update below], as it gives a slightly better result. Next, I scan through, and try to pick up comapnies that have poor economic returns compared with their historical averages. No great care goes into this, as it is supposed to be a fairly brainless strategy.

The two companies I chose to include are: KAZ (KAZ Minerals), and INDV (Indivior).

KAZ is a natural resource company that is actually losing money. It has £1.24b in EV (Enterprise Value), and £1.85b in revenue. That’s a EV/Sales of 0.67. Its mean is usually 2.38. Mining is a mess at the moment, everyone is bearish, and we could be at the start of a bear market in commodities that lasts more than a decade. So you’ve been warned.

INDV is a pharma company that was spun out of RB (Reckitt Benckiser) recently. It was described as a headache for RB, so they wanted to get rid of it. They sell a drug called Suboxone, which is for the treatment drug and alcohol addiction. The problem is that their revenues are declining due to competition from generics. INDV has a market cap of £1060m against TTM sales of £1147m. On that basis, it is incredibly cheap against its peers. The incredible scare card is that there is a firm expectation that sales will decline. There are replacement drugs in the company’s pipeline, however, so there is a lot of uncertainty as to how things will play out. Talk on the bulletin boards is virtually non-existent.

I own both shares, BTW.

I have tried an experiment of buying an American share through the Fantasy Fund, because I’m sure we’d all be interested to see how a portfolio of spin-offs performed. Unfortunately, the fund has valued the purchase at a negative value, so I’m not sure what’s going on there. I’ll probably just stick to UK funds. Life is hard enough without the components in my portfolio having negative values.

Anyway, that’s your lot for now. Happy new year to you all. May you all prosper in 2015. Could be a tough one, though.

Update 06-Jan-2015: Thanks go to @DangerCapital for spotting an error in paragraph 8. Where I said it would be nice if Stockopedia had an EV/EBITDA screen, I of course meant EV/EBIT. In fact, Stockopedia DOES have that (at least its inverse) in the form of Earnings Yield. I had completely forgotten about that. The book Deep Value has shown that Earnings Yield does win out by about 1%pa  over EV/EBITDA. Of course, Greenblatt’s formula uses EBIT/EV in his calculations, so I must apologise for having a bit of a senior moment on this.

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About mcturra2000

Computer programmer living in Scotland.
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