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John Reese
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John Reese is considered an expert in the systematic investing methodologies of legendary investors, including Peter Lynch, Ben Graham, Warren Buffett and many others. He has been active in the development of fundamentally-based quantitative models since the mid-90s. His commentary and research... More
My company:
Validea.com / Validea Capital Management, LLC.
My blog:
The Guru Investor Blog
My book:
The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies
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  • Gurus on a Roll with Retail

    Throughout the Great Recession and the ensuing turnaround that began in mid-2009, many analysts and pundits have said not to expect much help from the U.S. consumer in the economic recovery. Hamstrung by debt and at the mercy of a weak job market, Americans are going to save more and spend less, the theory goes, and weak consumer spending -- which makes up about 70% of the U.S. economy -- will mean weak overall growth for the country.

     

    But in recent months, the U.S. consumer has shown surprising resiliency. According to the Census Bureau, retail sales have risen in each of the past two months, and now stand close to 7% off their December 2008 lows. Some of that is due to bounce-backs in the price of gas and fuel, but other more discretionary-type industries are also well off their lows, including clothing stores; sporting goods, hobby, book, and music stores; and electronics and appliance stores.

     

    That strength has been a boost for a number of retail-related stocks, and my Guru Strategy computer  models, each of which is based on the approach of a different investing great, have done particularly well in that arena. As part of my new Validea Professional product, I track a number of industry and sector portfolios on Validea.com that use my guru-inspired models to find the top investment ideas in each area. Over the past month, my 10-stock Retail portfolio has been the best performer, gaining close to 17%, more than three times the gains of the S&P 500.

     

    My Retail portfolio also had a stellar 2009, gaining 61.2% vs. the S&P's 23.5% gain. Right now, it's particularly high on apparel retailers, which make up half of the portfolio. Here's a look at all of its holdings, which include big recent winners like Ross Stores (up 24.8% since Jan. 22) and The Buckle (up 27.3% since Dec. 24).

     

     



    Disclosure: I'm long UNTD, ARO, ROST, GME, JOSB, JAS, TJX, BKE, AMZN, and CASY.
    Mar 23 1:13 PM | Link | Comment!
  • The Best Investment Guru You've Never Heard Of

    If you haven’t heard of Joseph Piotroski, you’re not alone. He’s probably the least well-known of the investment “gurus” who inspired my strategies. Actually, he’s not even a professional investor, but instead an accountant and college professor.

    In 2000, however, Piotroski showed that you don’t need to be a smooth-talking Wall Street hot-shot to make it big in the market. While teaching at the University of Chicago, he authored a research paper that showed how assessing stocks with simple accounting-based methods could produce excellent returns over the long haul. No fancy formulas, no insider knowledge — just a straightforward assessment of a company’s balance sheet.

    His study turned quite a few heads on Wall Street. It focused on companies that had high book/market ratios — i.e. the type of unpopular stocks whose book values (total assets minus total liabilities) were high compared to the value investors ascribed to them (their share price multiplied by their number of shares).

    Quite often, such firms have low book/market ratios because they are in financial distress, and investors wisely stay away from them. On certain occasions, however, high book/market firms may be good companies that are being overlooked by investors for one reason or another. These firms can be great investment opportunities, because their stock prices will likely jump once Wall Street realizes it’s been shunning a winner.

    Through his research, Piotroski developed a methodology to separate the solid but overlooked high book/market firms from high book/market ratio firms that were in financial distress. He found that this method, which included a number of balance-sheet-based criteria, increased the return of a high book/market investor’s portfolio by at least 7.5 percent annually. In addition, he found that buying the high book/market firms that passed his strategy and shorting those that didn’t would have produced an impressive 23 percent average annual return from 1976 and 1996.

    Since I started tracking it on Validea.com in late February 2004, a 10-stock portfolio picked using my Piotroski-based model has outperformed the market, though with some big ups and downs. Over its first four-and-a-half years or so, it was more than five times ahead of the S&P 500. It was hit hard — like the rest of the market — in 2008, however, falling more than 37%, and it didn’t bounce back much in 2009, gaining just 6.8%. Still, despite the recent struggles, the portfolio is up 16.7% since inception, a period in which the S&P 500 has lost 4.3%.

    Let’s take a look at how Piotroski’s approach, and the model I base off of it, work.

    Diving into The Balance Sheet

    Piotroski wasn’t the first to study high book/market stocks. But his research took things a step further than many past studies. He noted that the majority of high book/market stocks ended up being losers, and that the success of high book/market portfolios was usually dependent on the big gains of a small number of winners. Much as low price/earnings ratio investors like John Neff used a variety of tests to make sure low P/E stocks weren’t rightfully being overlooked because of poor financials, Piotroski sought to separate the high book/market winners from the high book/market losers.

    The first step in this approach is, of course, to find high book/market ratio stocks. In his study, Piotroski focused on the stocks whose book/market ratios were in the top 20 percent of the market, so that’s the figure I use.

    That’s the easy part. The harder part is determining whether investors are avoiding a low-B/M stock because it is in financial trouble, or whether the company is a solid one that is simply being overlooked. The Piotroski-based model looks at a variety of factors to determine this, including return on assets and cash flow from operations, both of which should be positive.

    Several of Piotroski’s other financial criteria don’t necessarily look for fundamental excellence, but instead for improvement. This makes a lot of sense; a company whose return on assets had declined from 10 percent to 1 percent and whose cash flow from operations had dwindled from $10 million to $10,000 would pass the above ROA and cash flow tests, for example, but it certainly wouldn’t be the type of strong performer Piotroski was targeting.

    Among the other “change” criteria Piotroski examined were the long-term debt-asset ratio, which he wanted to be declining; the current ratio (current assets/current liabilities), which he wanted to be increasing; gross margin, which should be rising; and asset turnover, which measures productivity by comparing how much sales a company is making in relation to the amount of assets it owns (That should be increasing).

    As you can see, the Piotroski-based approach is a stringent one. Here are the ten stocks that rate high enough to make it into its 10-stock portfolio:

    Validea.com Piotroski-Based Portfolio

    Disclosure: I'm long IACI, PETD, OSG, SKYW, PTRY, OCR, IMN, CRDN, WINN, and AIZ.
    Feb 05 1:32 PM | Link | Comment!
  • Greenblatt on His Strategy: It's All about Discipline

    Often times, investors get the idea that beating the market requires complicated strategies, whether in the form of complex mathematical formulas or highly technical timing mechanisms. Others assume that an investor needs to have some sort of specialized, inside knowledge or God-given natural ability to produce strong returns over the long run.

    In 2005, however, Joel Greenblatt showed the investment world that all of those assumptions are wrong. In his Little Book that Beats the Market, Greenblatt laid out a two-variable, purely quantitative strategy that left the market in the dust over the long haul. According to his back-testing, the “magic formula” returned almost 31% annually from 1988 through 2004, a period in which the S&P 500 returned 12.4% per year. (As you’ll see below, my Greenblatt-based Guru Strategy has more recently produced similar outperformance.)

    This week, Greenblatt gave a rare interview, telling CNBC that his strategy is “really basic value investing, with a little Buffett twist.” While he dubbed this approach the “magic” formula, it is really grounded more in good old common sense than it is in the supernatural. One of its two variables, return on capital, identifies good, solid businesses that are using what they own to produce high profits. The other, earnings yield (which is similar to the inverse of the price/earnings ratio), makes sure you’re getting those companies’ stocks at good prices. And that’s it — strong companies at good prices.


    Ironically, Greenblatt told CNBC, the “magic formula” works over the long haul precisely because it doesn’t always work. “The great thing about this formula is it’s not that great [that it works all the time], meaning there are periods of time — could be two or three years sometimes, sometimes longer — where it underperforms the market,” he said. “And people usually give up on a formula that underperforms the market for that period of time.”

    Why is that a great thing? Well, if everybody stuck to the formula, Greenblatt says, the prices of those good companies the strategy identifies wouldn’t get to bargain levels. But since many bail on the strategy when it has an off year or two, disciplined investors are able to scoop up the bargains they’ve left behind. They can get stocks of those excellent companies at steep discounts by staying unemotional and disciplined, and sticking to their strategy. Those who don’t will often miss out on the bargains — and the excellent returns to which they often lead.

    The magic formula approach continues to work today, which you can see by looking at the Guru Strategy I created based on Greenblatt’s book. Since I started tracking it in late 2005, a 10-stock portfolio picked using the model has produced average annual returns of 10.5% — and that’s in a period in which the S&P 500 has lost 3.8% per year. The portfolio held up much better than the market in the horrific 2008 year, losing 26.3% vs. the S&P’s 38.5% loss. And this year it’s been red hot, gaining 65%, more than tripling the S&P’s gains.

    Greenblatt’s portfolio management style appears to be a bit different than mine. He told CNBC that he buys a portfolio of between 20 and 30 securities, holding individual stocks for about a year. I rebalance my portfolio every month (as I do with all my portfolios, having found that to produce the best results), and keep it more focused, at 10 stocks. Here’s a look at my Greenblatt-inspired portfolio’s current holdings:

                                    Validea Greenblatt-Based 10-Stock Portfolio

    Oct 20 11:17 AM | Link | 2 Comments
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