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I started a MFI portfolio about a year ago using a modified mechanical approach outlined in the book. My approach has been to buy two stocks each month based on the screen provided by Greenblatt. I screen three times using different minimum market caps and then rank the qualifying companies by earnings yield and ROE. Once I have the list (eliminating any duplicates) I then review the candidates looking for those with ten year earnings histories that show continuous profitability and relative continuity in earnings. Once I've done this screen I look for those companies selling near ten year lows on a PE, PB, and PS basis. Finally I give the earnings a quick once over to make sure that the EY isn't the result of an unusual event or uncharacteristically good year. Occasionally I'll take a chance on a company that doesn't fit the above criteria but has an interesting story, but I try to keep this speculative impulse to a minimum. Once these filters have been applied I usually have a few good candidates to choose from. I try to avoid letting macro concerns unconsciously drive my choices, which is a risk since I'm not just buying the top ranked names each month, but this method tends to eliminate cyclical businesses like mining companies.

So far the method seems to be working. I've been tracking performance by buying an equal dollar amount of the S&P500 index every time I make an MFI purchase. According to the Yahoo portfolio tracker my MFI portfolio is up 4.58% excluding dividends for the TTM while the S&P500 tracker portfolio is up 2.95%. This includes the cost of transactions for the MFI port while excluding transaction costs for the S&P500 tracker port. I think you need to do this because it more realistically tracks the alternative to actively managing the portfolio, which is to simply buy an S&P index fund and be done with it. While 1.65% points may not seem all that much, it is 55% better than the S&P500. Of my 24 positions, 5 are down by 5% or more, 12 are up by 5% or more, and 7 are relatively flat. My top three gainers are up 65%, 42% and 28%, while my bottom three losers are down 37%, 26%, and 19%. Clearly diversification is necessary if you are going to spend as little time as I do engaging in company specific research. This was his point in developing the formula, I think, and so far I'd say it's working.

I have to say that the MFI approach requires a bit of discipline. What I like about it is its mechanical approach to value investing. My problem in the past has been a sporadic approach to investing and an unwillingness to sell. The MFI approach forces me to exercise discipline by adjusting the portfolio on a monthly basis. In a previous discussion on this board someone raised the issue of churn due to the one year holding period. I plan to always sell all my losers at 364 days and to usually sell winners at 365 days unless the winner is still on the MFI list, in which case I will hold it for another year. I think this will reduce the churn and allow some deeply undervalued positions the time to mature.

I've noticed a little bit of disillusionment with the MFI approach by some posters on this board. This is not surprising as Greenblatt argues that the approach works because most investors simply don't or can't have the patience and discipline it requires. Value investing works, there is no question about it. If it so obviously works then why doesn't everyone become a value investor? And what would happen if everyone did adopt a value approach to investing? The answer to the second question is that the approach would no longer work if everyone adopted value investing because the market would become the efficiency machine some already assume it to be. The answer to the first question is more complicated. I think that speculation is occasionally, and handsomely, rewarded so that many will always be tempted to speculate. Additionally, the time horizon of many investors is simply too short to engage in a value approach to investing. How often have value fund managers had to close up shop because their investors have withdrawn their capital due to “better opportunities” elsewhere? The need to show results on a quarter by quarter basis drives decision making on Wall Street, and for this reason alone value investing will always be a better long term methodology. It's also the reason I think some people grow quickly impatient with the approach.

I will give an update again next year this time.

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