Here at magicallyinvested.com we adhere to a value oriented investing style. We follow a 10 point system in order to conduct fundamental analysis on individual companies that we are evaluating for purchase. Before evaluating a company though we first adhere to a few Key Principles:
- Adequate but not excessive Diversification
- Dollar Cost Averaging
- Minimize Risk first before trying to Maximize Returns
- Don't swing at every pitch- wait for one you are confident in
Adequate but not excessive Diversification
In our philosophy we believe that it is important to have a diversified portfolio, provided it is not excessive. We advocate holding a portfolio of between 10 and 30 stocks. Any more than this and you cannot possibly keep up with enough details of each company in order to make sound investment decisions. Any less than 10, and you run the danger of being too concentrated in 1 or more industries. We advocate that the choice on exactly how much stocks to hold will depend on the amount of time and effort you are able to spend. If you cannot spend at least a few hours per week on analysis following the 10 point magicallyinvested.com system, then we advocate holding a minimum of 20 stocks. Second to the number of companies in your portfolio is also the industry diversification. Some of the greatest value investors including Warren Buffett have at times held very concentrated portfolios in a few select companies or industries. We advocate that you should only do this if these companies are fully within your "circle of competence" .
Dollar Cost Averaging
We fully believe that investors over the long run should not try to time the market. There are too many macroeconomic variables that are always conflicting with each other, making this a fools game. As a result we advocate a philosophy of regular monthly or quarterly purchases of stocks in good times and in bad. Over the long run this has been shown countless times to be a strong recipe for investment success.
Minimize Risk first before trying to Maximize Returns
Value investing is as much about minimizing risk as it is maximizing returns. We believe at MagicallyInvested.com that long term success will come when you focus first on wise and carefully chosen investments with an eye for avoiding any situations where there are potential catastrophic risks. If there are any possibilities that a single event could cause that business to have major disruption or even cease to exist within 1 or 2 years, then we will not invest in it. Examples could be a company thats fundamental business model is threatened by changes in government legislation, or also a company whose revenues and profits are hugely dependent on 1 or 2 major customers.
Don't swing at every pitch- wait for one you are confident in
We follow our strict 10 point system to decide whether to make a purchase or not. If we cannot find any companies in a month meeting our criteria, then we will "wait for the next pitch" and keep the money in cash.
We have developed a 10 point system that we use to score potential companies we evaluate for purchase.
- A score of 9 - 10 is a strong buy
- A score of 8-9 is a buy
- A score of less than 8 we don't buy
Scoring is done as follows:
|Criteria||Point Value Range||Description|
|Magic Formula||0 - 2||The basis of our methodology is rooted in following the MagicFormulaInvesting.com strategy as created by Joel Greenblatt. Please view our disclaimer on this. We start by looking at companies that are in the top 50 stocks over 50 million in market cap as the basis for our screening. A company on the list receives a score of 2. Companies that are not on the 50 over 50 million but are on the 50 over 1 billion or 3 billion screens receive a score of 1. If the company is not on either list it receives a score of 0. Note that since we only consider investing in a company with a score of 8 or higher, this implies that if a company is not on the magic formula screens we will only consider investing in if it passes 100% of all other criteria. This is because we believe strongly in the principle of the magic formula where you focus on businesses generating high returns on capital trading with low EV/EBIT multiples. Also it should be noted that sometimes we look at foreign equities, which do not show up on the magic formula screens. If they have a greater than average return on capital, generally >20% consistently, and low EV/EBIT multiples for the industry then we will consider this a score of 1.|
|Circle of Competence||0 - 2||It's key that you understand the businesses you are investing in. When you buy a stock, you are purchasing an ownership stake in a business. The more you understand about the company, its industry, competitors, etc the better you are able to evaluate its future prospects and how much the company is worth today. For these reasons we weight this criteria above the remaining ones and give it a point value of 2.|
|Moat||0 - 1||Most companies we analyze have a high return on invested capital. Businesses with such high rates of return would normally attract a lot of attention from competition, which could hurt margins over time. We look at barriers to entry and the competitive landscape to objectively value a companies business Moat to assess how likely it is they can sustain high rates of return in the coming years.|
|Margin of Safety||0 - 1||We believe that calculating the intrinsic value of a company should be done using a simple discounted cashflow (DCF) method. Our belief is that the most logical definition of how much a company is worth is simply to say that it is worth the value of all of its future discounted earnings. Earnings should be discounted at the risk free rate, and an additional margin of safety given to how confident you are in your earnings projections. We then look for a margin of safety in the purchase price where a 50% or greater upside potential exists. If a company's current market price gives a lower upside opportunity to intrinsic value, then we will score this criteria lower.|
|Shareholder Friendly||0 - 1||Although a company is owned by its shareholders, nobody knows in reality the inner workings of a business as well as its management. There are unfortunately countless ways in which a company's management can deceive shareholders. We will score this criteria with a 0.5 if a company pays a steady increasing dividend, is committed to share buybacks, or has clear management alignment with shareholders through high levels of insider ownership. We will score this a 1 if two or more of these factors are present.|
|Conservatively Financed||0 - 1||Here we look for low debt to equity ratios and a strong current ratio (>2). Businesses with low debt are much less likely to run into troubles during economic downturns, and this aligns with our philosophy to focus on risk avoidance.|
|Good Business Prospects||0 - 1||We initially screen for strong cheap companies based on their past results. Although this is seen as a good indicator of potential future results, a business that is in a dying industry or one with poor near term prospects is likely to have some difficult times ahead. A company can only increase earnings so much with cost cutting and efficiency initiatives - sustained earnings growth in the long term will only occur with sustained revenue increases. We therefore find it important to evaluate the prospects for growth in the business.|
|Predictable Earnings||0 - 1||Forecasting future growth rates can be a dangerous and difficult game. We like businesses that are easy to understand with predictable and stable earnings as demonstrated over the past 10 year period. This is crucial for us to be confident about our intrinsic value calculations. The simpler, more predictable a business is, the more we like it.|