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Author: TwinDeltaTandem Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 41629  
Subject: Re: The BMW Screen...er, Method Date: 12/15/2006 3:55 PM
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Bill,

I think you're overlooking a fundamental difference between Joel Greenblatt's frame of reference versus what the BMWm is trying to do. Greenblatt is coming to his MFI approach from the perspective of someone who has started with Piotroski and tried to simplify it. Like many other mechanical value screens, Piotroski works (way) best for companies with no analyst coverage. Although he doesn't say as much, I get the impression that Greenblatt's DD discussion is within this context--developing pro forma financials for relatively small, non-covered companies. [Now here's the chink in my argument--Greenblatt himself seems to favor very large, highly covered companies, e.g., WMT, ARO, AXP, AZO, LYV and LEA. But the MFI approach has nothing to do with Greenblatt's personal approach to managing funds.]

To beat the market you need to have an advantage--some overlooked aspect of buying and selling securities. The premise of the BMWm is that the tenacity of a company's long-term CAGR is something that is generally overlooked when evaluating a stock's current price.

Given this, as BMW and others have said, DD does not require a tremendous amount of pro forma work. If the underlying fundamentals are historically consistent, and if the price has consistently demonstrated a reversion to its long-term CAGR (as supported by these consistent underlying fundamentals), then a negative deviation from the long-term CAGR constitutes an actionable datum. The DD required to establish both of these facts is not that difficult.

Take WMT:

http://charts.grahaminvestor.com/WMT.php

The underlying fundamentals are rock solid. The only reason that the stock price isn't a perfect log curve is due to inefficencies in the market. Our DD focuses on whether we can trust the numbers and whether WMT today is the same as the WMT that produced the fundamentals in the past.

On the other hand, consider DRL:

http://charts.grahaminvestor.com/DRL.php

At first glance, this looks like a BMW stock. However, the underlying fundamantals have a problem. Not only that, but we find through DD that the historical data is suspect. Therefore, this stock becomes a speculative play rather than a BMWm value stock.

Furthermore, unlike WMT, DRL is a very small company. Unlike Piotroski, Greenblatt the value guy, et. al., BMW is primarily looking for very large companies with very, very long histories of stalwart performance.

Greenblatt's comment that few people could/should execute DD should be limited to its intent. I think his intent was to point out the difficulty of predicting the futures of companies like DRL rather than those of very large, established companies like WMT, MMM, LM, or even HD. For such companies, the past is far more predictive of the future.

John

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