Some numbers

With Boeing’s factories running at peak capacity to keep up with strong demand for new jetliners from airlines seeking fuel-efficient planes, a strike is expected to cost the company roughly $100 million a day in lost revenue – Wall Street Journal

I disagree with the WSJ journal as the revenue will not be lost unless the contract to build an airplane is canceled, otherwise the revenue is deferred.

The company’s final contract proposal included a pay raise of 11% over the life of the contract, as well as a boosting of pensions by 14% to $80 a month for each year of service. Under the proposed contract, the average union member would earn roughly $65,000 a year before overtime that averages $10,000 a year or more.

Interested in how much an experienced machinist makes, I gave our own machinist a call about machinist wages. A kid coming out of “school” can expect to make anywhere between $15-$20/hr (sounds good eh?).  A more experienced machinsist can easily earn somewhere between $30-$40/hr. Basically, Boeing is offering  union workers, assuming overtime pay, the higher end of what a machinist would earn otherwise.

Leverage

The machinist have a ton of leverage as Boeing could not afford any more delays. Boeing expects to start delivering its 787 Dreamliner (2 years behind schedule) in 2009. At the same time, its customers are getting a bit impatient as emerging market countries like China and UAE need new airplanes to keep up with demand. Other customers who are looking for more fuel efficient fleets also cannot wait for their airplanes to get delivered. Thus, I expect the union to get what they want as the longer the strike goes, the more impatient Boeing’s customers and shareholders get.

Wild Card

There’s a wild card in this novella. Washington State’s Governor Christine Gregoire who was responsible for the 48 hr extension. As the governor of Washington, its very important for the governor to finalize a deal as Boeing is a major player in Washington’s economy. According to this video,for every Boeing job, there are 4 jobs associated indirectly with it such as suppliers.

ederal mediators and Gov. Chris Gregoire, D-WA are trying to delay a possible Boeing employee strike, with CNBC\’s Phil Lebeau

Be prepared

The story for Boeing is simple and thus time to map out a plan. The stock price will be hit short term, but should be fine once this novella is finished and Boeing actually starts delivering some airplanes. With my original purchase price of $64, I plan to average down every 15%. Cash will be raised through the sale of non-magic formula stocks such as Proctor and Gamble (PG)

Disclaimer: I own BA and PG

Seth Klarman is known as an investor who keeps a low profile while heading the Boston based  Baupost Group. When the Baupost Group establishes a sizeable position, one has to take notice. It is no coincidence the firm has averaged 20% annual returns since 1983. According to this 13G filing, Baupost Group bought 2,255,318 shares of Centerplate (CVP). I haven’t looked at Centerplate’s latest SEC Filings but I am assuming the position has to do with Centerplate looking for a buyer. I wouldn’t bet on Centerplate (CVP) without further due dilligence as Seth Klarman’s picks are tough to figure out without spending significant time on them, then again that’s why they have impressive returns.

One thing I have noticed about the magic formula screen is, as the market moves higher the quality of businesses decreases. Also, as the market moves lower, the quality of businesses increase. Let me explain. When the market was making new highs (remember 14,000?), I recognized few if any stocks on the list and had to do a lot more reading to be well informed on what company “x” is doing, its future plans, etc… This is how I discovered Accenture (ACN) which I sold at $34 and is now at $40 (see image). Now the markets are in bear market territory and some familiar names are appearing. When running the magic formula screen, I use the top 25 results for the following market caps: 50, 250, 500, 1000, 2000. This way I am able to see which stocks appear the most. For example, a company like Perini Corp. (PCR) appears in the magic formula screen (top 25) for the 50, 250, 500 million minimum market cap. Obviously, for Perini to show in 3 of the screens it must be ranked high. Also, I ran the 700 mill minimum market cap screen and it appears there.

50 Million Market Caps – Top 100

American Eagle Outfitters (AEO)- The stock of this popular teen retailer tanked after its chief marketing officer resigned bringing the stock to some historic low levels. Be careful though, company has auction rate securities (ARS) on hand which it might have to write down or take a write off. When and if it does, stock may go down providing an opporturnity. I established a small position on that basis.

Barrett Business Services (BBSI)-  My favorite among the staffing companies (there are many on the magic formula list). Obviously, its been beaten down as less people are hired during recessions. Also, temporary workers are usually the first to get the boot in bad times as companies downsize to keep expenses down as revenue decline or stay flat. One has to love a CEO who tells Wall St “If you guys want to sell [the company] down to five times earnings, maybe I will just buy the whole [expletive] thing.” The company has $5 in cash.

Boeing Co. (BA)- Nice backlog but cannot get a plane off the ground.  At these levels, I am interested and might establish a position.

Coach Inc. (COH)-  Their bags are expensive, yet women love them.

Frontier OIl Corp. (FTO)- Best of breed refiner suffering due to low (negative?) refining margins. Any increase in the spread would really help this company.

FreightCar America (RAIL)- Haven’t really checked the story but I know it has been talked about in the value investing community.

Gannett Co. Inc. (GCI)- Declining industry, stay away. A.K.A. Value Trap

Hansen Natural Corp (HANS)- Their MONSTER Drinks might not be selling like before but company has other great drinks. Might be worth investigating.

Herman Miller (MLHR)-  The maker of office furniture (known for their Aeron chair) showed up on my screen today. I’m impressed with their ability to continue results despite a weak U.S marker. Their management has given analysts nothing to chew on in the guidance front and I like it. I get the feeling that management is telling analysts “Do your homework”. Anyway, the company is doing a great job of getting their products in front of customers and selling on quality, quick delivery, etc.  A pretty straight forward plan for success.

Lear Corp. (LEA)- Struggles as long as auto industry struggles. Any rebound in auto sales will help company.

Manitowac Company (MTW)-Now, I have spent a good deal of time reading their statements. Thesis is simple: the company continues to expand globally but is getting pounded due to its domestic operations. Its Crane division might be worth more than its current market cap. The company is doing a fine job of expanding into India and China. Now, if the US Market recovers (which it will) its stock price can really run.

McGraw-Hill Companies Inc (MHP)- The maker of textbooks and owner of Standard and Poor’s has been beaten down for some reason, might be due to its S&P division but not sure. I read a while back their textbook sales in decline mode, but with me paying $100+ for a textbook I can see why

NVIDIA (NVDA)- Stock tanked 30% on Friday. Not in circle of compence

Perini Corp. (PCR)- Slowdown? What slowdown? You wouldn’t know there was a slowdown by reading their reports. The company has a 7 billion+ backlog and is planning to expand into Dubai and other foreign countries.

Premier Exhibitions (PRXI)- Interesting company as it deals with museum exhibition of the Titanic (something along those line).

These are the type of companies and stories you can find while the market is down. For a company to like Boeing (BA) to appear on the list using such a low market cap screen is interesting. I am 99% confident it will appear in the rest of the screens, in which I will make different post. Now, by no means is this a final list of companies to look into. The list above only mentions 15 out of the 100 companies that appeared using a minimum market cap of 50 million and 100 results. The other companies I have either mentioned before (ACN,PACR,etc..) or have not looked into as I usually look into the top 25.

I wanted to comment on the other screens (250, 500, 1000, 2000) but the article was getting a little lengthy so I am going to break them into pieces.

Disclosure: I own AEO, MTW, PCR, BBSI, MLHR

Although not the most sophisticated screener, it is an additional feature that adds an extra feature to Google Finance. The screener is located next to the “Get Quote” button.  I still find Yahoo Finance’s integration of stock reports and message boards to be the best around with MSN Money coming a close second. In terms of screeners, nothing I know of beats MSN Deluxe Stock Screener which amazingly is available for free.

First, UPS operates in a duopoly with FedEx in the package delivery industry (not counting the US Postal Service). UPS is generally considered more consumer oriented, while FedEx is considered more business oriented. Now, it was over the weekend when I realized how big a moat these two companies have, in particular UPS. Considering I do not work on weekends, I decided to chill out and watch television. I came across the National Geographic’s “Ultimate Factories: UPS”. I highly recommend watching it as it takes the world behind the scene’s of this massive operation. i found a small video of the show on Youtube (below) so you can get a glimpse of what I am talking about.

Lately, I have been trying to dig into moats (or competitive advantage) and I cannot think of a better example than UPS. Think about it, if one sees a big brown truck, what comes to mind? UPS. DHL (3rd among package deliver companies) only wishes its “Yellow” could be as prominent as UPS’s “Brown”. Sorry, but not happening soon. Even though DHL has made strides to catch up with UPS and FedEX I doubt they will ever catch up. Why? To start competing with UPS, DHL needs to processing capacity to compete in terms of price. To compete in price, it needs the volume. Volume has been improving but not at the sufficient pace to make a profit. Until recently, DHL has been keeping its head above waters, but the recent run in oil has put them in the red. Thus, DHL turned to UPS to handle its air operations. Basically, UPS will make money without any capital investments.

This is another advantage of UPS. Every additional package that gets loaded on a truck goes to the top line. The expenses will have little variance (driver, fuel, maintenance) , but revenues will increase with every package added to the truck. Also, businesses are very loyal to UPS. In my family’s business, UPS is the only choice to deliver packages. With a couple of clicks, I can print out a label, drop off the package at a UPS Store, UPS drop box, or if I see a UPS truck pass by, the package will be delivered to our customer in 2-3 days (we usually ship ground). Also, we have used their freight services and have never had a problem. Whether the equipment was shipped to Vietnam or New York, the equipment arrived i one piece, on time and at a reasonable rate, that’s all I ask for.

When thinking of moats, I often ask myself what would it take for a competitor to really make an impact? Answer: A boatload. Anyone trying to compete with UPS (and FedEX) will have the same issues as DHL, trying to compete at a grand scale with a not so grand customer base. As time goes on, UPS will continue to only increase its most. First, its technology is constantly being updated which will only add costs to future competitors and further increases its efficiency (decreases expenses). Second, every customer added to UPS, is one less customer for future competitors. Third, billions of dollars will have to be spent on brand awareness. Note to competitors, the following colors are taken; Brown, Yellow, Black, and I remember a service with Green….

Disclouse: I own shares of UPS

Johnson Controls is currently trading at multiples it has not seen since the turn of the millennium. Although, it will not provide catastrophic returns, JCI should do fine as the economy and the market recovers.

This company supplies building controls and energy management systems, automotive seating, and batteries. -S&P Report

Below are some of the numbers
P/E: 14
Forward P/E: 11
ROE: 15%
ROA: 5%
EV/EBITDA: 8

Disclaimer: I own shares of JCI through an investment club

Value Investors were left disappointed as they felt the last edition of Security Analysis, authored by Cottle, Murray, and Block, had very little “Graham and Dodd” left in it. Even the first edition of Security Analysis receives criticism for being published in an era where bargain were plentiful due to the Great Depression. Thus, Value Investor’s are left with the 2nd,3rd and 4th editions of Security Analysis to satisfy their Graham and Doddism. Nevertheless, I am impressed with the lineup McGraw-Hill has selected for the 75th Anniversary edition which will include a forward by Warren Buffett. This lineup might rival that of the 1927 New York Yankees, arguably the greatest baseball team ever assembled which included names like Ruth, Gehrig, Cobs, Koenig, Meusel, Lazzeri. So who will step up to the plate? (pun intended)……

• Seth Klarman, presindent of Boston’s The Baupost Group and author of a really expensive book.
• Bruce Greenwald, Professor of Finance and Asset Management at Colombia’s Business School and author of Value Investing: From Graham to Buffett and Beyond
• J. Ezra Merkin, Gabriel Capital Group
• Bruce Berkowitz, Fairholme Capital Management
  
• Glenn Greenberg, Chieftain Capital Management
• David Abrams, Abrams Capital Management
• Thomas Russo, Gardner Russo & Gardner, will write about global value investing

One of the criticisms of Security Analysis has always been that the style of writing is very vague. I agree. But, included in the list of authors and is not mentioned above is Roger Lowenstein author of Buffett: The Making of an American Capitalist, which in my opinion is the best Warren Buffett biography around.

Many value investors already have a copy of Security Analysis on their library. I think this edition will not be disappointed based on the lineup McGraw-Hill has assigned to update the book. The names listed above, and those not listed, are well known in their respected fields and bring years of practice to the table. I am especially looking forward to the forward by Warren Buffett. His introduction in The Intelligent Investor is a classic in my opinion and has set the bar high for his introduction in Security Analysis.

Lets get straight to the point and rank the stocks as described in the book.Visit this page to rank the magic formula stocks, the site will rank the magic formula stocks and cut down the fat on which companies to invest in. I have to thank “streetcapitalist” from valueinvestingnews.com for providing this link. Now the due diligence begins. It is up to the investor to decide how deep in security analysis they want to get into. Now that we have the rankings, it is time to separate the good from the ugly.

The first thing I do is weed out the companies I understand. This is easy as either you get it or you do not. The action for this is as follows. Head over to Yahoo Finance, type in the stock symbol and click on profile. For Heely’s (HLYS), the profile looks like this.

In the case of Heely’s, it is understandable so it might be a candidate. The problem with the magic formula is it contains a lot of beaten down businesses. For example, biotechs whose products were not approved by the FDA or their main product is going to lose its patent. Another example might be the business whose earnings peak as the economy peaks. To weed out the good from the ugly head over to morningstar.com

Again, at this stage we are simply sorting the good from the ugly. Type in the ticker symbol, on the left side click “Key Ratios”. The screen should look something like this: (click on pic to enlarge)

As the picture illustrates, NVTL ’s (currently ranked 16th) numbers are all over the place. Everything from profitability and ROE% are inconsistent and does not merit any more time. What you want are consistent numbers like ARO ( a former magic formula stock).

Now time to get into some security analysis. I start with the S&P 500 reports provided by my broker and read as much as possible about the company through their SEC filings, and news (going back 2 years) . Everyone has their methods so I really cannot dwell onto this. Next, time for some valuation.

As far as I can tell, most magic formula stocks will carry a low P/E with them. Depending if I have time, one half of my buy decision will come from this. The other half will come whether or not the stock is trading at a 52 week or all time lows. This alone is dangerous but has worked well for me so far. Finally, if you are a fan of discounted cash flow models (I am not), Joel Greenblatt does hint on them in the book (pages 40-47).

The first thing we need is some analysts estimates on how much are earnings are expected to grow for the next 5, 10, 15, 20+ years. Not too many people can predict earnings that far and that is why I do not like DCF models. Again, head over to Yahoo Finance and click on “Analyst Estimates”. Scroll down until “Growth Estimates” appears. We are looking for “Next 5 years Per Annum”. (picture below)

Five years is a short enough period where the numbers are semi accurate. In the above picture, Heely’s is expected to grow 5% for the next 5 years. How accurate is that depends on your analysis of the company. As everyone knows, Heelys is a one product company and that itself might be a optimistic estimate. To be cautious, I highly recommend cutting back on growth estimates for any company. For example, if a company is expected to grow 15%, assume 10% growth. Now time for some valuation. I am going to assume you have a growth rate, discount rate and earnings per share for the past twelve months. Next, go to moneychimp.com’s discounted cash flow calculator and insert numbers. This will give you an estimated intrinsic value. Next, cross your fingers the stock is selling at a discount and buy or move on.

Aeropostale (ARO) is a recent example of a magic formula stock that I bought and sold. When I bought the stock, I found it on the magicformula website and on the 52 week low list. I knew the business as it is one of my favorite place to shop. All the numbers and story seemed fine and I bought it on a low P/E & 52 week low basis. If I had done the process detailed above, it would have been a good illustration. Analysts expect the company to grow 17% for the next 5 years. I could assume 12% for the next five years discounted at 10%. I would also assume either a 1% growth rate after 5 years or no growth at all. The 1% is a discount to U.S GDP growth (2-4%?) . No growth because the business has no moat and competition is plentiful (AEO, ANF, etc).Also, retilaers have a shady record. The 12% growth for the next five years and a 10% discount rate would give me an intrinsic value of $28.00. Aeropstale’s 52 week low is $18.xx, providing a 34% margin of safety. Again, that was assuming reduced growth rates and no growth after 5 years. Joel Greenblatt recently sold between $28 and $31.

Finally, this by no means is a tell all article on which magic formula stocks to invest in. This is simply what works for me. Feedback welcome. How do you select magic formula stocks?

Disclaimer: I own not stocks mentioned above; as stated I once owned ARO

1. 1949, The Intelligent Investor by Benjamin Graham is published. Warren Buffett describes it as “the best book on investing ever written”, The Intelligent Investor provides “in a form suitable for the laymen, guidance in adoption and execution of an investment policy”.
2. Second on the list is Warren Buffett’s acquisition of Berkshire Hathaway. Currently a conglomerate, Berkshire Hathaway would become Warren Buffett’s investment vehicle. Throughout the years, the shareholder letters would become the the publics value investing wikipedia.
3. At the age of 29 (1959), Warren Buffett is introduced to Charlie Munger.Munger would stray Warren Buffett from Benjamin Graham’s philosophy of diversification and low P/BV. Munger influences Buffett to avoid ‘Cigar Butts’ and invest in companies with wide moats. In addition, Munger influences Warren Buffett to run a more concentrated portfolio.
4. At the height of the internet bubble Institutional Investor publishes a cover with the headline, “Value Investing: Can It Rise from the Ashes?”, which questions the future of value investing. Similarly, the New York Times comes out with the headline “What’s Killing the Value Managers?”, which highlights the beating value oriented managers took to hot growth funds. Although, many at the time questioned Value Investing, the time tested strategy would prove it still works as high flying stocks get crushed when the bubble finally bursts.
5. In a speech at Columbia University commemorating the 50th anniversary of Security Analysis, Warren Buffett gives arguably the best speech on value investing. The Superinvestors of Graham-and-Doddsville introduces the world to super investors like Walter Schloss, Bill Ruane,Tom Knapp, Ed Anderson, Rick Guerin and Stan Perlmeter, names that very few people have heard of, but nonetheless have produces outstanding returns.