Wednesday, 28 October 2015

Update to New 52 Week Lows Screen

As I've continued tracking 52 week lows in order to generate ideas for further research, I've discovered the following:

1) The process of tracking 52 week lows is more important than finding ideas:

I started this process in July 2015 and I've managed to refine my own internal process of screening along the way.  For example, when I first started this exercise, my weekly list was close to 200 entries: I basically took every single new low off the new lows listing ad hoc.

As I've progressed through my daily review of new lows, I have a number of filters going on inside my head before ideas make my tracking spreadsheet:

  • Reasonable to (preferably) no leverage, 
  • Preferable small to micro-caps, 
  • Ignore P/E within reason, as it's symptomatic of what has happened, not what may happen going forward.  Also, negative eps in any one year is not a reason for exclusion as loss years may be symptomatic of transition.
  • Want to see high enough gross and operating margins over at least 5 years (possibly indicative of pricing power / competitive advantage)

2) Pretax cap rate (EBIT / EV) may produce a number of interesting ideas for further research, but FCF Cap Rate is a better metric for identifying candidates:

I've developed my tracking list with a view to researching ideas where the pretax cap rate, EBIT / EV, is sufficiently high (in excess of 15%).  I am not seeing a ton of ideas (especially lately).

But what I'm really interested in is valuation.  Since I've been ranting all along on the merits of free cash flow, I've decided to add a TTM FCF column to my list, and I've done a very quick and dirty "perpetual" FCF calculation using FCF / .12 , +/- net cash (the difference between EV and mkt cap) in order to take the ratio of 1 - ((FCF / .12) +/- net cash ) / Market cap.

This is my own quick and dirty calculation for margin of safety at 12% Re.

This way, I have both my preliminary pretax cap rate + a simple analytic for FCF perpetual no growth valuation lined up next to each other on the screen.  If I get hits with a high enough pretax cap rate in excess of 15% and a possible capitalized FCF discount to current market cap, I may have the beginnings of an idea for further research

3) All of the above is very boring:

It is a monotonous process.  It means sitting down at my screen nightly and logging results in. Hopefully though, the process is akin to "painting a fence".  Here's a quote from Joel Greenblatt's Little Book on just this:

"I LOVE MOVIES, and The Karate Kid is one of my favorites. Of course, I would like any art form where eating popcorn and candy are part of the deal. But there is one scene in this particular movie that holds special meaning for me. In it, the old karate master, Mr. Miyagi, is supposed to be teaching his teenage apprentice, Daniel, how to fight. The boy is new at school and being bullied by a group of karate-trained toughs. Daniel hopes learning karate will help him stand up to his tormentors and win the girl of his dreams. But instead of teaching him karate, Mr. Miyagi puts Daniel to work—waxing cars, painting fences, and sanding floors.

So after a whirlwind of scenes showing poor Daniel working his fingers to the bone—waxing, painting, and sanding—the youth has finally had enough. He confronts Mr. Miyagi and essentially says, “Why am I wasting my time doing these simple and menial tasks when I should be learning karate?” Mr. Miyagi has Daniel stand up from his sanding duties and starts throwing jabs at the young boy while yelling “Wax on! Wax off!” Daniel deflects each jab with the swirling motions he learned from so many hours waxing cars. Next, Mr. Miyagi throws a punch while yelling “Paint the fence.” Once again, Daniel deflects the punch, this time using the up-and-down action of painting a fence. Similarly, Mr. Miyagi’s karate kick is then stopped by Daniel’s expert floor-sanding ability. 

In effect, by learning these few simple techniques, Daniel has unwittingly become a karate master. Now in good movies, the viewer participates in something called the willing suspension of disbelief. In other words, we kind of know that Ralph Macchio, the actor who plays Daniel in the movie, couldn’t really use that waxing thing to defend himself in a dark alley. In the real world, before he could finish his first coat, Mr. Macchio would probably get smacked in the head and drop like a sack of potatoes. But while caught up in a movie, we’re ready and more than willing to believe that Mr. Miyagi’s simple methods can truly work wonders."

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