Bogle, Siegel, O’Shaughnessy: Where Do They Have Their Own Money?

While they have been hit hard over the past year, many of the world’s top investors aren’t shying away from the stock and bond markets, writes The Wall Street Journal’s Eleanor Laise. In fact, many have been snatching up bargain stocks and bonds for their own personal portfolios while most investors have been fleeing the market.

“A sampling of high-profile industry veterans, academics and brokerage-firm chiefs reveals that many are hanging on to holdings battered by last year’s market slide and busily hunting down new opportunities, particularly among bonds and beaten-down value stocks,” Laise explains “And they’re generally upbeat about the prospects for long-term retirement savers.”

The gurus Laise examines — who include Jeremy Siegel, David Dreman, and Jack Bogle — aren’t the only ones putting their own money where their mouths are.

Reports Reuters’ Jeffrey Hodgson: “With the global financial system mired in crisis and Western economies deep in recession, fund manager James O’Shaughnessy is so bullish on stocks he is pouring his own cash into the market.”

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There’s Magic in Greenblatt’s “Magic Formula”

I’ve added a new investment model to my arsenal. It’s based on the “Magic Formula” strategy that Joel Greenblatt outlined in The Little Book that Beats The Market. Some of what you’ll find below is a recap of a post I did last week, but in this post I’ve also included the ten stocks that are currently in my Greenblatt-based portfolio.

The beauty, and attractiveness, of Greenblatt’s “Magic Formula” lays in its perceived simplicity. The purely quantitative approach has just two variables: return on capital and earnings yield. Greenblatt’s back-testing found that focusing on stocks that rated highly in those areas would have produced a remarkable 30.8 percent return from 1988 through 2004, more than doubling the S&P 500’s 12.4 percent return during that period. Greenblatt also posted impressive numbers in his money management experience, with his hedge fund, Gotham Capital, producing returns of 40 percent per year over a span of more than two decades.

The table below shows Validea’s 10-stock monthly rebalanced Greenblatt portfolio since we began tracking it in December of 2005. The strategy slightly underperformed in ’05 (though keep in mind that because of its December inception, the ’05 numbers only include the final month of that year), but since 2006 it has beaten the market each year.

As Greenblatt explains, the two-step formula is designed to buy stock in good companies at bargain prices — something that other great value investors, like Warren Buffett, Benjamin Graham, and John Neff also did. The return on capital variable accomplishes the first part of that goal (buying good companies), because it looks at how much profit a firm is generating using its capital. The earnings yield variable, meanwhile, accomplishes the second part of the task — buying those good companies’ stocks on the cheap. (The earnings yield is similar to the inverse of the price/earnings ratio; stocks with high earnings yields are taking in a relatively high amount of earnings compared to the price of their stock.)

While the Greenblatt stock-picking approach is purely quantitative, Greenblatt stresses the mental aspect of using the “Magic Formula”. To Greenblatt, the hardest part about using the formula is having the mental toughness to stick with the strategy, even during bad periods. If the formula worked all the time, everyone would use it, which would eventually cause the stocks it picks to become overpriced and the formula to fail. But because the strategy fails once in a while, many investors bail, allowing those who stick with it to get good stocks at bargain prices. In essence, the strategy works because it doesn’t always work — a notion that is true for any good strategy.

Below you will find the Greenblatt-based model’s Current Portfolio, which represents the highest scoring stocks as of the Jan. 28 close.

What Does It Mean to be a Value Investor?

In a piece written for Forbes.com’s “Gurus’ Guide to 2009“, John Heins and Whitney Tilson do a great job in examining just what makes an investor a value investor.

While value investors come in all shapes and sizes — large-cap, small-cap, activist, non-activist, U.S.-focused, foreign-focused — Heins and Tilson list 12 similarities they share. A sampling:

  • They focus on intrinsic company value and buy only when there is a substantial margin of safety, rather than trying to guess where the herd will go next.
  • They understand and profit from reversion to the mean rather than projecting the recent past indefinitely into the future.
  • They understand that beating the market requires a portfolio that looks different from the market.
  • They spend far more time reading things like business publications and financial reports, rather than watching the ticker or TV shows about the market.
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J. Zweig on Forecasting & Black Swans

Jason Zweig unveils some great research in his latest piece for The Wall Street Journal (“Why Market Forecasts Keep Missing The Mark”). With all sorts of pundits making predictions for where the market will head in 2009, Zweig says you should be skeptical of their forecasts — and your own — a notion that I also examine in detail in my new book, The Guru Investor.

Says Zweig, “Nearly all of us try forecasting the market as if each of the past returns of every year in history had been written on a separate slip of paper and tossed into a hat. Before we reach into the hat, we imagine which return we are most likely to pluck out. Because the long-term average annual gain is about 10% we ‘anchor’ on that number, then adjust it up or down a bit for our own bullishness or bearishness.

“But,” he continues, “the future isn’t a hat full of little shredded pieces of the past. It is, instead, a whirlpool of uncertainty populated by what the trader and philosopher Nassim Nicholas Taleb calls ‘black swans’ — events that are hugely important, rare and unpredictable, and explicable only after the fact.”
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‘Good to Great’ Author Collins: “Those Who Panic, Die On The Mountain”

Jim Collins, author of the top selling business books “Built to Last” and “Good to Great”, speaks with Fortune magazine about what it takes for companies to emerge from difficult periods in history. “A couple of things really jump out,” he says. “No. 1, in times of great duress, tumult, and uncertainty, you have to have moorings.” Highly successful firms have “incredible fabric of values, of underlying ideals or principles that explained why it was important that they existed.”

The video below is previous interview Collins had done on the Charlie Rose show and is worth listening to if you want to learn more about Collins and his insightful research on highly successful companies.

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Reese on New Guru Model, Economy

In his latest Hot List newsletter, Validea CEO John Reese unveils a new guru-based stock selection model, and tells readers that continuing economic woes don’t have to mean continued trouble for the stock market.

Reese’s new Guru Strategy is based on the writings of hedge fund master Joel Greenblatt. Greenblatt created quite a stir in the investment world in 2005, when he published “The Little Book that Beats The Market”, in which he explained how investors could produce outstanding long-term returns using his simple “Magic Formula”. The purely quantitative approach had just two variables: return on capital and earnings yield. Greenblatt’s back-testing found that focusing on stocks that rated highly in those areas would have produced a remarkable 30.8 percent return from 1988 through 2004, more than doubling the S&P 500’s 12.4 percent return during that period. Greenblatt also posted impressive numbers in his money management experience, with his hedge fund, Gotham Capital, producing returns of 40 percent per year over a span of more than two decades.

Reese has been internally tracking his Greenblatt-based model since late 2005, and it has beaten the market in each of the past three years.

In reality, Reese writes, the “Magic Formula” is less about magic than it is about simple, common sense investment theory. As Greenblatt explains, the two-step formula is designed to buy stock in good companies at bargain prices — something that other great value investors, like Warren Buffett, Benjamin Graham, and John Neff also did. The return on capital variable accomplishes the first part of that goal (buying good companies), because it looks at how much profit a firm is generating using its capital. The earnings yield variable, meanwhile, accomplishes the second part of the task — buying those good companies’ stocks on the cheap. (The earnings yield is similar to the inverse of the price/earnings ratio; stocks with high earnings yields are taking in a relatively high amount of earnings compared to the price of their stock.)

While the Greenblatt stock-picking approach is purely quantitative, Reese notes that Greenblatt stresses the mental aspect of using the “Magic Formula”. To Greenblatt, the hardest part about using the formula is having the mental toughness to stick with the strategy, even during bad periods. If the formula worked all the time, everyone would use it, which would eventually cause the stocks it picks to become overpriced and the formula to fail. But because the strategy fails once in a while, many investors bail, allowing those who stick with it to get good stocks at bargain prices. In essence, the strategy works because it doesn’t always work — a notion that is true for any good strategy.

Reese also touches on the economy’s continued struggles, and warns stock investors not to mistake the economy for the stock market. Even if the economic news continues to be rough, he writes, that’s no guarantee that stocks will fall. Consider that in two very high unemployment periods ((1975 and late 1982), bull markets actually began about seven months and four months, respectively, before unemployment peaked.

The issue for stock investors is, as always, value, Reese says, adding that, based on a variety of measures — price/book ratios, forward price/earnings ratios, and even the ultra-conservative 10-year P/E ratio — stocks are undervalued. “That means it’s a good time to be buying (or staying) in stocks, regardless of the short-term economic fallout,” he says.

Grantham on Cycles, Bargains, and the “Creative Tension” Facing Stock Investors

In an excellent interview with Steve Forbes, Jeremy Grantham — the bear who called both the 2000 market crash and the recent plunge — discusses how he’s avoided the bursting bubbles, talks about the areas of the market that intrigue him now, and reasserts his assertion that stocks are cheap, but likely to get cheaper

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