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Investing

The Little Stock That Beats The Market

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By Douglas A. McIntyre Published
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From World Beta

Joel Greenblatt recently wrote an investment book titled "The Little Book That Beats The Market." It included a description of an investment strategy focusing on a magic formula with two inputs – high return on capital and a high earnings yield. The book is a great intro into factor based equity screening. Currently he owns four stocks – Wal Mart (WMT), American Express (AXP), Autozone (AZO), and Aeropostale (ARO). You can follow along with his holdings here.

Interestingly enough, Grennblatt’s siter runs her own hedge fund (Saddle Rock Capital) with ~ $170M AUM. Even more interesting, she only owns two stocks – Aeropostale(ARO, 2.9M shares) and Abercrombie and Fitch (ANF, 1.2M shares). Talk about some serious cajones! But then again, it was none other than Buffett himself that said, "Wide diversification is only required when investors do not understand what they are doing."

So, the Greenblatt’s own over 3.5M shares of ARO, and its at new highs after breaking through a quadruple (quintuple?) top. Technicians everywhere are salivating. . .

But does high conviction as an idea result in excess returns, or is it simply an example of the gambling nature of hedge funds?

Morgan Stanley has developed a screen based on the hedge fund conviction premise. They examine stocks in the S&P 500 that have 1) high hedge fund ownership in percentage terms, 2) but owned only by a few funds (meaning it is their best idea(s)).

They take the top 25 stocks where the hedge funds own the highest % of shares outstanding. From that list, they select the 10 lowest number of hedge fund positions. They rebalance 15 days after the 13Fs are filed (60 days after the Q end). Their database includes survivor bias (it doesn’t include stocks that are no longer traded), which, at least in our research so far, biases the results up a few hundred basis points.

Regardless, they found the strategy significantly outperformed the indices over the 1999-2006 time period. The results are a bit fantastic (500% total return for the strategy vs. ~ 20% for the S&P over the same time period), but it bears watching.

Posted by Mebane Faber

http://worldbeta.blogspot.com/

Photo of Douglas A. McIntyre
About the Author Douglas A. McIntyre →

Douglas A. McIntyre is the co-founder, chief executive officer and editor in chief of 24/7 Wall St. and 24/7 Tempo. He has held these jobs since 2006.

McIntyre has written thousands of articles for 24/7 Wall St. He is an expert on corporate finance, the automotive industry, media companies and international finance. He has edited articles on national demographics, sports, personal income and travel.

His work has been quoted or mentioned in The New York Times, The Wall Street Journal, Los Angeles Times, The Washington Post, NBC News, Time, The New Yorker, HuffPost USA Today, Business Insider, Yahoo, AOL, MarketWatch, The Atlantic, Bloomberg, New York Post, Chicago Tribune, Forbes, The Guardian and many other major publications. McIntyre has been a guest on CNBC, the BBC and television and radio stations across the country.

A magna cum laude graduate of Harvard College, McIntyre also was president of The Harvard Advocate. Founded in 1866, the Advocate is the oldest college publication in the United States.

TheStreet.com, Comps.com and Edgar Online are some of the public companies for which McIntyre served on the board of directors. He was a Vicinity Corporation board member when the company was sold to Microsoft in 2002. He served on the audit committees of some of these companies.

McIntyre has been the CEO of FutureSource, a provider of trading terminals and news to commodities and futures traders. He was president of Switchboard, the online phone directory company. He served as chairman and CEO of On2 Technologies, the video compression company that provided video compression software for Adobe’s Flash. Google bought On2 in 2009.

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