Expected Returns - Manifest Investing

Expected Returns
Editor: Mark Robertson, Manifest Investing LLC
Results, Remarks and References Regarding Investment Initiatives
Volume XVI, No. 2 February 2008
The Shadow of Success
You can’t have a shadow without a little sunshine. And as it turns out, a front porch in
the Tennessee foothills is a pretty good place to enjoy some sunshine and companionship. 2007 Groundhog Challenge Champion Steve Parham leaned on his dog, Bo, to
dominate a formidable field of groundhoggers over the last year. Steve and Bo turned
$500 into $724 during a year when the markets were quite unforgiving. That’s a rate
of return of 43.1% while the overall market DECLINED 2%. 19-of-25 participants
managed to beat the market, delivering an average rate of return of 5.3%. Those are
super results that even Bill Belichick and the New England Patriots could love.
We knew the field of competitors was in trouble from the launch. During a playful exchange on the MANIFEST Forum, Steve Parham shared, “My dog
won’t hunt but I like him just fine.” A year ago we talked of profiles in courage and recognized a few proud participants who were
willing to step up to this fray. (Steve and Bo had already assumed
the early lead.) Here’s a closer look at where our hogs have been
... and where they seem to be headed.
But it’s just a “game?” Aren’t you taking these 5-stock portfolios a little
too seriously? Perhaps. But when 25 people step up and stick their necks
out and make a legitimate effort to outperform the market, we think it
merits some attention.
We didn’t dwell on the long-term nature of the contest a year ago. But
our participants clearly made their choices with a longer journey in mind.
There was no day trading. No penny stock adventures. Instead, companies like Fastenal (FAST) were among the favorites.
One year later ... 19-of-25 participants have outperformed the market
so far. We know better than to dwell on the results of a single year. We
also know that past performance doesn’t mean that this will continue. I
think it will continue not because of past performance but because we’re
dealing with a group of investors who build portfolios with carefullyconsidered expectations in mind. The challenge was simple. Select five
stocks, starting on our national holiday, Groundhog Day -- and take care
of the portfolio going forward. There were no limitations on trading except that we account for capital gain liabilities to encourage switches to
be effective. Realized losses are accounted as offsets in a simulation of
tax-based incentives.
Punxsatawney Phil’s Prediction?
We closed a year ago with: “ ... a group [of investors] that heeds the lessons of Graham, Babson and Nicholson has at least one leg up on the crowd
and a better than average opportunity to generate exceptional returns.”
Steve’s 43.1% would be outperformed by ONLY two domestic stock equity
funds (Ken Heebner’s CGM Focus and a highly-leveraged commodities fund.)
The average groundhog at 5.3% outperformed 86% of U.S. equity mutual
funds. I think Punxsy Phil would forecast “Spring Ahead” for our hogs.
Steve Parham and Bo take home top
honors in the 2007 Groundhog Challenge.
Their selections of Dynamic Materials
(BOOM), Options Express (OXPS), NAVTEQ
(NVT), Select Comfort (SCSS) and Volcom
(VLCM) during early 2007 went on to deliver a 43.1% rate of return for the 2007
contest. Steve and Bo switched to Starbucks (SBUX), Lowe’s (LOW) and Almost
Family (AFAM) during November 2007 and
dominated the leader board for most of
the year. Congratulations, Steve and Bo!
In This Issue...
Garmin (GRMN) ................... 3
Fidelity Sel Technology (FSPTX) .... 4
Mutual Fund Manifest ... 5
Sweet “Sixteen” ........... 6
Tin Cup Model Portfolio ... 7
www.manifestinvesting.com
A Few Moments with ... Steve Parham
MI: Congratulations, Steve (and Bo) on winning the
first segment (2007) of the Groundhog Challenge.
Many of us would aspire to “keep up with Heebner”
and 43.1% so far is a solid start. What sparked your
interest in investing?
Steve: I graduated from college in 1990 with a BS in
Computer Science. A year later, my grandmother gave
me 5 shares of stock in Cracker Barrel as a Christmas
gift. She included a note that I still cherish. She talked
about how time and a good growth stock can be very
rewarding and gave an example of a friend who bought
a few shares of Ralston Purina in the 1940s. It paid no
dividend at the time, but over the years it split many
times and was now 600 shares paying a nice dividend.
I also still have the first dividend check that CBRL sent
me - I never did cash that $0.04 check! I began buying
stock in 1993 after joining the National Association of
Investors (NAIC.) My early purchases included Dell,
Lands End, AFLAC and Merck.
MI: How does your hunting-averse dog come by his
name?
Steve: (laughing) Bo? He’s adopted. His given name
was Rambo -- which was a bit much for us. He was
aggressively trained to be a narcotics dog, but didn’t
make it.
MI: (laughing) Rochester, Michigan is home to
Leader Dogs for the Blind. We see those program
refugees all the time, too. What’s your day job?
Steve: I’m currently designing and building software
applications at Oak Ridge National Laboratory.
MI: Can you describe the stock selection process that
you used for the Groundhog Challenge?
Steve: Sure. I chose my original 5 stocks by looking for:
(1) High expected growth. Above 15% and preferably closer to 20%.
(2) High PAR as projected by MI.
(3) A recent history of earnings surprises.
(4) I looked at MI financial strength and earnings stability numbers to help narrow down my choices, but I
did not have any set limits for these.
MI: Is there a statue of you outside any brokerage
firm? Maybe on Wall Street someday?
Steve: Ha!
MI: Thanks, Steve. Good luck in 2008!
2 - Expected Returns - February 2008
Groundhog Leaderboard at One Year. Here are the (19)
participants who outperformed the stock market benchmark
(VTI) as of Groundhog Day 2008. The average hog delivered a
rate of return of 5.4%, better than 86% of U.S. equity mutual
funds over the past 12 months.
Peer Performances
Our runner up, Saul “The Stockinator” Seinberg has
a message for this year’s champion. Congratulations ... but rest assured, I’ll be baaaack. You and
your dog are girly men, resting on the laurels of the
NAVTEQ acquisition. (grin) You can’t hide behind
those unrealized gains forever.
All kidding aside, Saul’s 24.5% rate of return and high
accuracy (62.5%) are a force to be reckoned with going
forward. Apollo Group was the 4th-best stock selected
and the position is closed ... or locked in on the hall of
fame roster. (See page 8)
Carol Clemens picked three of the best-performing
stocks (the only hog with three) and delivered a 19.0%
return and made the accuracy leader board.
Rebecca Osborne (18.3%) rode Sigma Designs (SIGM),
the 2nd-best performing stock, to the top of the leader
board. She has admitted that she loves the phrase, “...
Sigma Designs will destroy the rest of the Groundhog
field.” She’s compassionate but competitive.
Will Conrad (15.3%) tied with Lowell Herr for the highest
stock picking accuracy (80%) and his five out-of-the-box
stocks, including #8 So. Peru Copper (PCU) fared well.
... continued on page 8
Solomon’s Select: Garmin (GRMN)
A year ago we featured NAVTEQ (NVT) the company
that makes the digital maps that GPS companies
like Garmin use. NVT (Steve and Bo’s best-performing Groundhog stock) is in the process of being
acquired at $78, a 122.1% increase over the last
year. Who can blame us for hoping that lightning
may strike twice with another navigational leader?
Garmin (GRMN) is a provider of navigation, communications and information devices, most of which are enabled
by global positioning system (GPS) technology. The
Company designs, develops, manufactures and markets
a diverse family of hand-held, portable and fixed-mount,
GPS-enabled products and other navigation, communications and information products. Garmin operates in four
segments: Marine, Automotive/Mobile, Outdoor/Fitness
and Aviation.
Growth
Garmin (GRMN) uses the tagline, “We’ll take you there.” We’ve
known for a very long time that “real men” don’t stop to ask for directions. It’s just not something that’s done -- something that has frustrated throngs of wives and girlfriends since ... well, since the beginning of time. I think Garmin should put together some really creative
ads for the Super Bowl. Because some really smart people have taken
a few satellites, some computer chips and a portable display to deliver
a technology that means all men can “ask” for directions without the
world knowing. You can’t build a better mousetrap. Right, guys?
Source: 2006 Garmin Annual Report
According to Value Line, the estimate for sales growth
is 13.7%. Some subscribers feel that VL has a rather
“pessimistic history” with Garmin. The long-term trend
for sales growth is greater than 40%.
Profitability
The trailing 4-year average for net margin is 28.5%. Based
on a 20% sales growth forecast, the margin would have to
be 28.1% to achieve a 5-year EPS estimate of $8.63. The
forecasted net margin for 2007 was 27.6%.
Valuation
The industry average projected P/E for Electronics is 20x.
Value Line has a projected average P/E of 21x. Based on
P/E forecasts by S&P and historical trends, a P/E of 14-29x is
feasible. The current P/E was 19.5x at the time of selection.
Garmin Visual Analysis. With historical rates of 30-40%, the $64
is when do things slow down? Answer: They already are. This makes
forecasting a little tougher. The 20% growth rates shown here are based
on the lower growth rate (sales or EPS) for the current three-year period
(including forecasts.) The EPS growth forecast for 2007-09 is 20%.
Expected Returns, Quality & Conclusions
Based on a price at the time of the study of $64.94, the projected annual return was approximately 22%. The quality
rating is 93.8 (Excellent). The financial strength index is 99%.
A couple that we know from Denver won a Garmin GPS at a
national convention a couple of years ago. They used Garmin
on the drive home and say that it saved their marriage. I
remember a nearly empty gas tank and a pitch black night
somewhere west of Salt Lake City several years ago. My wife
does, too. A friend recently wondered whether MANIFEST
might be Garmin-like for investing. We hope so.
Garmin - Profitability Trend. There is some pressure on maintaining
margins at historical levels but the track record is enviable.
February 2008 - Expected Returns - 3
Featured Fund
Fidelity Select Technology (FSPTX)
by Cy Lynch, Chief Education Officer
The MANIFEST methodology is unique because of its
forward-looking emphasis. The projected returns for the
individual holdings of funds are analyzed and used to
compile a projected return for a universe of funds. Our
emphasis in the study of funds is not on where the fund
has been, but where it seems to be going.
This Month’s Fund Finding
We screened all mutual funds covered by MANIFEST for
Projected Annual Returns (PAR) greater than the total stock
market (12.2%) and Quality Ratings (QR) greater than 60.
The result is Fidelity Select Technology (FSPTX).
A Glance in the Rearview Mirror
FSPTX’s annualized total return for the 10 years ending
12/31/07 was 9.65%, exceeding that of the broad stock indices. The fund outperformed the broad market in half of those
10 years, most recently outperforming the S&P 500 by 14 percentage points in 2007. Morningstar gives it a three-star rating.
Expected Returns
FSPTX’s portfolio PAR of 19.1% exceeds the projected return
for the general stock market by 5.9 percentage points, one of
4 - Expected Returns - February 2008
the largest advantage thresholds we’ve seen in MANIFEST’s
three years of fund coverage. Its expense ratio is below average for managed funds at 0.89%.
Knowing What You Own
FSPTX’s holdings are profiled in its portfolio dashboard below.
Portfolio average QR is excellent (65.4) and average financial strength is solid at 73.3. It has the highest projected
sales growth of all MANIFEST-covered funds (19.7%) and the
average projected P/E reflects that relatively higher growth
at 28.1x. EPS Stability (32.8) is very low, indicative of the
fund’s historical (and likely future) volatility. FSPTX’s historical returns, however, are vivid reminders that volatility isn’t
all negative, potentially presenting opportunity when holdings
are high quality.
FSPTX holds 151 stocks (as of 11/30/07) with nearly 50%
and 65% of its holdings concentrated in the 10 and 25 largest ones, respectively. Sixteen of the top 25 (including the
five largest and seven of the top 10) holdings have PARs at
or above our suggested advantage threshold MIPAR plus 5
percentage points. Half of those 16 holdings have PARs more
than 10 points above MIPAR, reflecting some potential for
disappointment if they prove too good to be true. At the other
end of the continuum, only three of the 25 largest holdings
have potential returns significantly below MIPAR.
February 1, 2008. Listing of equity funds ranked by Projected Annual Return. Projected Annual Return: Average forecast return (adjusted for expense ratio) for holdings based on growth forecast, profitability, and projected annual P/E ratio.
Minimum condition: PAR > MIPAR+2% to qualify for this listing. Quality: Average quality rating of the holdings. (0-to-100,
Greater than 65 = Excellent, Minimum = 60) Sales Growth: Average sales growth forecast for holdings. Yield: Average
projected annual dividend yield for holdings. P/E: Average projected annual P/E. Financial Strength: 100% = Highest
EPS Stability: Ranking based on variation in annual change of EPS growth for companies held. Figures in parentheses denote prior month rank. (*) denotes new to list. Funds listed in bold have been previously featured.
Management Decisions
FSPTX is one of the oldest specialty technology funds, having
started on 7/14/81, and has consistently ranked in the top
five percent of technology funds over its 25+ years of existence. With a fairly high turnover rate of 113%, FSPTX is very
much a manager-driven fund. Its current manager, Yun-Min
(Charlie) Chai, has headed the fund since the first of last
year. While his tenure at FSPTX has been short, Mr. Chai has
worked with Fidelity as a stock analyst and portfolio manager
in the technology sector since 1997. In addition, Morningstar
points out that he has done well at the helm of Fidelity Advisor Technology (FATEX) since 2005.
Since October, Mr. Chai added four significant new positions,
all having expected returns above the market as a whole:
Garmin, Mindray Medical, Qualcom and Hewlett-Packard. The
first two have current PARs more than five percentage points
above MIPAR. He also added to 14 of FSPTX’s 25 largest holdings. Those accumulations look appealing having an average
PAR of 17.7%, more than five percentage points above MIPAR.
His largest reduction during that time was Network Appliance
(reducing holdings by 65%) which has a current PAR just one
percentage point above MIPAR. On balance those decisions appear positive from a MANIFEST advocate’s perspective.
The technology sector as a whole presents attractive investment
opportunities, evidenced by VIPERs Vanguard Technology (VGT)
having the best expected returns of the ten sectors tracked on
our ETF Sector Radar. Nine of the 20 funds, including the top
four, on this month’s Fund Manifest are technology funds.
FSPTX stands out particularly strong with a PAR two percentage points higher than that of VGT, the second ranked fund on
the Manifest. That combined with having the highest projected
sales growth rate of all covered funds (along with excellent
overall quality and solid financial strength) makes FSPTX an extremely attractive addition to an otherwise diversified portfolio.
It’s not for the faint of heart, but investors with the patience
and willingness to endure significant volatility could profit by
allocating up to 10-15% of their portfolio to the fund.
Cy Lynch is chief education officer at MANIFEST and responsible for fund research and
program development. Cy is an Atlanta
Braves fanatic, a respected and experienced long-term investor and contributor to
educational efforts for the National Association of Investors Corp (NAIC.) Cy served on
the NAIC national board of advisors. He is
a registered investment advisor and can be
reached at: [email protected]
February 2008 - Expected Returns - 5
Manifest - Screening Results
Sweet “Sixteen” Screen - February 2008
The screening results shown here deliver a group
of high quality companies with fairly high return
expectations. The list includes companies with
projected annual returns between 17.6-22.6%
and financial strength ratings of 70% or better.
Overall Market Expectations
The median projected annual return (MIPAR) for all 2800+
stocks followed by MANIFEST (Solomon database) is 12.6%
(1/31/2008.) The multi-decade range for this indicator has
been 8-20%.
Worth a Closer Look Now
Despite relaxing the financial strength criteria to 70%
(B++) only (14) companies qualified under the criteria
listed below.
The highest-rated companies based on a ranking including (but not limited to) PAR and quality rating are
Buffalo Wild Wings, Accenture and FactSet Research.
The lowest price-to-fair value ratio among the Sweet
“16” for S&P is Garmin (75.6%). The lowest price-tofair value ratio according to Morningstar is Accenture
at 65%. Only 1-of-the-14 (Accenture) have Strong
Buy ratings from either S&P or Morningstar. The favorite among the CAPS All-Stars is Healthextras with
a CASPI rating of 100.0%. All (85) of these CAPS
leaders expect HLEX to outperform the S&P 500. The
average price-to-fair value ratio for the Sweet “16” now
stands at 96%.
Lowest relative strength index: Chicago Bridge & Iron
is potentially “over sold.”
Highest “buying pressure”: It may be Super Bowl related, but Companias Cervecarias (CU) has the highest money flow characteristic. While the Clydesdales
and Dalmations square off in the annual Super Bowl
advertising slugfest, it may be that our sudsy attention
should be focused south of the border?
As the accompanying graphic shows, VLMAP and MIPAR
are at multi-year highs. Shop for sudsy returns.
Sweet 16 Screening Result for February 2008. Companies shown in bold are new since last month. Screening parameters: Projected Annual Return between 18.3-23.3%. Financial Strength 70% or higher. Quality higher than 65.0.
CASPI > 95%. Definitions: TTM Sales: Revenues for trailing 12 months. Net Margin: Projected net margin (profitability) forecast in 3-5 years. P/E Avg: Projected average annual price-to-earnings ratio in 3-5 years. * - Expanded
Coverage. Note: Financial firms use Shareholder Equity and Return-on-Equity (ROE) instead of sales and net margin.
6 - Expected Returns - February 2008
Tin Cup Model Portfolio
Sell Strayer (STRA), Buy BWLD, CBI and GRMN
Our “Tin Cup” model portfolio is a
standing feature intended to demonstrate the MANIFEST portfolio design
and management approach. Our
mission is to maintain the portfolio
design characteristics within defined
ranges and deliver superior long-term
returns. All buying and selling decisions will be detailed here.
Total assets are $713,650 (1/31/08)
and the net asset value is $187.94.
The model portfolio slid 2.37% during
January 2008 (Wilshire 5000 checked
in at -6.08% for the month!) and has
generated a +0.5% total return over
the trailing year vs. -2.8% for the
total stock market.
Portfolio Characteristics
With MIPAR at 12.6%, our target for the
minimum overall portfolio PAR is at least
17.6%. The overall portfolio PAR is
16.3% on 1/31/2008. Quality and financial strength are sufficient at the current
levels of 78.7 (Excellent) and 93%. EPS
Stability is 87 for the portfolio. Sales
growth has declined to 11.2%.
Tin Cup Dashboard - January 31, 2008. The holdings are ranked by PAR
(last column on the right.) All six “sweet spot” stocks are ineligible for accumulation.
Strayer has the lowest PAR in a portfolio with insufficient overall PAR.
Decisions
The dashboard has been sorted by
descending PAR. This immediately
“flags” the lowest PAR stock (Strayer)
for evaluation and decisions. TSS is
the result of a spin-off from Synovus. We’ll take a closer look at these
“fragments” as more information and
forecasts become available.
The “before” portfolio PAR was only
16.3%. We need at least 17.6%.
The Strayer position was sold. Because of the size of the STRA holdings (nearly 14% of total assets) the
proceeds-from-sale were distributing among the three highest-ranked
companies according to Solomon.
Please welcome Buffalo Wild Wings,
Chicago Bridge & Iron and Garmin
to the Tin Cup portfolio. The “after”
portfolio PAR is 17.9%.
Strayer Education (STRA). We hardly knew ye. I can remember having
some reservations about Strayer when it popped up at the top of the selection charts back in July 2005. I was apprehensive and we’d never looked at
Strayer for any of the MANIFEST portfolios that we track. We knew very little
about the company but we’d seen some pretty rough treatment of Apollo and
Corinthian and others. This is where one of the virtues of Tin Cup kicks in ...
because the rigidity of the rules suppresses emotions that often interfere with
success for long-term investors. We didn’t have a choice. Let me repeat that
-- Strayer was the top-rated stock in our universe at the time. We didn’t have
a choice. Strayer proceeded to DOUBLE since August 2005 and bolstered Tin
Cup results vs. the market.
February 2008 - Expected Returns - 7
Groundhog 2007 Results
Shadow of Success (cont.)
The lone investment club entry, our Crow River Club of
Minneapolis, represented themselves well, momentarily
topping the leader board not that long ago. Their success inspired over a dozen investment clubs to try their
hand at the 2008 Groundhog Challenge.
Lowell Herr came within thirty minutes and one selection of a 100% accuracy rating. Lowell’s lone wolf
strategy centers around selecting exchange-traded
funds (ETFs) that he believes will outperform the market. Four of his ETFs did precisely that ... and the fifth
missed by 0.2%. He believes that his strategy probably
can’t win, but it won’t “lose” either -- and Lowell expects results in the upper-half of all contestants.
One of the more fantastic finishes came from the
Zebras portfolio -- as Coldwater Creek advanced over
80% in the last two weeks of January to propel the Zebra portfolio from market-trailing to the leader board.
There wasn’t a whole lot of turnover with the whole
group averaging a 66% annual rate. That’s a little high
-- but still lower than the average stock mutual fund.
Some participants did their part to hold up the group
average. Specifically ... Bob “Fence Busting” Wheeler
did his best imitation of a Van Waggoner mutual fund
but still focused a great deal on fundamentals. Still, his
sixteen sales transactions led the field by a pretty wide
Best Performance by Groundhog Selections. Feb-2007
Solomon Selection NAVTEQ turned in the top performance
among the couple of hundred stocks (and ETFs) chosen over the
course of the year. We’ll track these results going forward. [c]
denotes a position that is “closed” that will no longer fluctuate.
margin. We call him “No Moss” for a reason. Bob’s 8%
relative rate of return and 52.4% accuracy are a shadow that shouldn’t be ignored. Keep up the good work.
Seeing a Groundhog Future
We don’t know whether there’s six more weeks of correction or bear market or an imminent recession. We
also know better than to cast too much emphasis on
the results of one year and we admit that there’s some
luck and timing involved. We also expect some of the
laggards of 2007 to be among the leaders of 2008.
They’ll be joined by over a dozen investment clubs
as the field expands to (50) participants and we’re
also going to playfully monitor a few celebrity (rhino)
groundhogs, including a dart-tossing chimpanzee.
Accuracy Icons. We define accuracy as the number of picks
that outperform the general stock market index. In other
words, a selection with a relative return greater than zero. Will
Conrad and Lowell Herr were the kings of precision for 2007.
But we do know this. The vast majority of selections
are made with quality and expected returns in mind.
That fact alone separates our wonderful group of courageous groundhogs from the field of average investors and bodes well for future shadows of success.
Contact Us
You may write us at Manifest Investing LLC, P.O. Box 81120, Rochester MI 48308. If you prefer e-mail, contact us at
[email protected]. Every effort will be made to answer your questions individually. Your inquiries, comments
and recommendations tell us what you want to see and we’ll do our best to provide it.
(c) Manifest Investing LLC 2005-2008. All rights reserved. All efforts are made to use factual and timely sources believed to be reliable. No warranties whatsoever are implied. This publication and affiliated services represent an educational demonstration. NO
INVESTMENT RECOMMENDATION IS INTENDED. Manifest Investing LLC has no affiliation with Value Line Publishing, Inc. nor the
National Association of Investors Corp. (NAIC) The managers and members of Manifest Investing LLC may directly or indirectly hold
shares in the companies or mutual funds that are reviewed in this publication. Web site: http://www.manifestinvesting.com
8 - Expected Returns - February 2008