My hypothesis is that performance can be improved above that of index funds (i.e., broadly diversified funds) because broad diversification in an indiscriminant fashion captures the good, the average, the mediocre, and the bad. And as the screens from return on tangible capital and earnings yield show, there is a long average-mediocre-bad tail. If we can take steps to slice off that tail (e.g., Magic Formula filter) that can go a long way to improve performance. Of course, then there's the problem of diversifying within the remaining companies.
In Bill Miller's apologetic shareholder letter, he mentions that the main reason Value Trust underperformed the indices was that the tail has flattened: where before there were three opportunities, two of which had $12 selling for $10 potential, one having $30 selling for $10, now there are three $12 selling for $10 opportunities. So the broadly diversified strategy works better than concentrated due to lower risk.
He mentions he still believes there is potential appreciation in growth, though, if not in value stocks.
I think it is worth spending some time going deep on the good ideas I've come across so far: Contango, Delta Financial, and FreightCar America. Not only will this serve to firm up the exit plan, it will also build a comparable by which we can judge other related investment opportunities. If the opportunity at hand beats one of these, then it's interesting.
Look at some recent recommendations:
- Tyco break-up value
Some interesting stocks that are showing up in the magic formula screens:
- SAIC (20% ROTC, 23% earnings yield)
- Domino's Pizza (55% ROTC, 11% earnings yield): recap adding 1.85B debt, paid out $13.5/shr dividend. Debt/ebitda 7x (mgmt prev said comfortable w/ 3-6x), 2.2x interest coverage. Revenues $1.4B, I est 240MM ebitda. It generates cash, but can it pay down that debt? Interest according to Lehman paper is $113MM.
Asset allocation:
Continue reading on commodities - no rush as they're probably overpriced now
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