Hedge fund guru Joel Greenblatt of the $7.88 billion Gotham Asset Management fund has made some key portfolio shifts in Q1 including slashing position in Advanced Micro Devices, Inc. (NASDAQ:AMD) and NVIDIA Corporation (NASDAQ:NVDA), while increasing position in Apple Inc. (NASDAQ:AAPL).
Greenblatt, who has an impressive four-star ranking on TipRanks, is also the famous author of “The Little Book That Beats the Market” which describes his “Magic Formula” for investing. He says the formula finds the market’s top 30 stocks – cheap stocks with a high earnings yield and a high return on capital. According to Greenblatt, this strategy has a 17-year annual return of over 30% and beats the S&P 500 96% of the time.
Recently a research paper put Greenblatt’s formula claims to the test. Douglas W Blackburn and Nusret Cakici of Fordham University discovered that the magic formula is “not so magical”. They plotted portfolios of long and short stocks for 23 markets in 4 global regions from 1991 to 2016, and found that the only region with significant return differential was Europe.
However, “much more magical” returns were created by the researchers when switching EBIT for gross profit. The new formula therefore uses gross profit-to-tangible capital employed and gross profit-to-enterprise value. The result: profitable value stocks outperformed unprofitable growth stocks by a noticeable return differential of 0.88% (North America), 0.65% (Europe), 0.66% (Japan) and 0.62% (Asia). Interestingly, risk is also significantly reduced by this formula- which suggests that maybe a magic formula does exist after all!
Greenblatt has certainly been enjoying some success with the Gotham portfolio which has gained almost 71% since June 2013. But while the fund’s measure performance easily beats that of the average hedge fund portfolio it nevertheless fails to outperform the S&P 500’s measured performance of 88%:
So how did Greenblatt’s investing strategy play out in Q1 2017? Let’s take a closer look at three of his most interesting trades:
Advanced Micro Devices Slashed
Greenblatt slashed his holding of AMD by a whopping 65% to just $473,500. The stock is now just 0.01% of the Gotham portfolio.
Recently the stock had been enjoying a boost from rumors that AMD’s larger rival Intel (INTC) had signed a deal with the semiconductor company to cross-license its graphics technology. Such a deal would create a significant revenue stream for AMD. However this bubble now appears to have ben burst as, on May 18, Intel called the rumors “untrue” and absolutely denied that there was any such collaboration with AMD. Share prices, which had soared 25% when the deal was first reported by Fudzilla, subsequently lost all their gains.
Top JP Morgan analyst Harlan Sur– who is ranked #323 out of 4,556 analysts tracked by TipRanks- also dismissed the rumors following AMD’s annual analyst meeting day on Thursday. “We came away with a view that AMD would not likely license core IP to a competitor” said Sur.
Furthermore, a close analysis of Intel’s current $264 million/ year agreement with chip company Nvidia is worded in such a way that some speculate that the agreement will not expire, but will continue in perpetuity. The mutual release claims include the crucial words “fully, finally and forever” which could explain why Intel is creating new processors due to launch in the second half of the year- when, on the face of it, the agreement should have expired.
But an interesting take on the AMD/ Intel situation arises when you consider that the source that denied the rumors is not necessarily any more reliable than the source that supplied the rumor to Fudzilla in the first place- who is likely to also be an anonymous Intel employee. In which case, we are back to square one and the AMD/ Intel rumors can continue for a little while longer still.
Based on 16 analyst ratings on the stock over the last three months, AMD has a Moderate Buy analyst consensus rating on TipRanks. The 12-month analyst price target of $12.86 is a 12.7% upside from the current share price of $11.40- which is now 25% down from its 52-week high of $15.55.
Greenblatt whipped up Apple by 22% in the first quarter. The holding, which now stands at close to $60 million, still only makes up 0.75% of the portfolio even though it is the fund’s ninth biggest stock. Since the last filing date, these shares have already appreciated by close to 7%.
Apple still has an appealing mix between growth and value, Greenblatt recently revealed to Forbes, adding that growth is part of how a business is valued. The fund manager praised Apple’s cash flow, especially given that you “don’t have to pay a big price for it.” Greenblatt believes that other fund managers, such as Warren Buffett, continue to like Apple because the business is worth much more than the current stock price. Buffett owns $18.58 billion of Apple shares.
Top Wells Fargo analyst Maynard Um has a more cautious take on the stock. Five days ago he reiterated his Hold rating with a very bearish $140 price target (8.5% downside from the current share price). He refers to the ongoing patent battle between Apple and its smartphone modem supplier Qualcomm (QCOM) as a source of concern. Qualcomm has recently upped the ante by suing Apple’s iPhone and iPad manufacturers Foxconn, Pegatron, Wistron, and Compal for refusing to pay- after these companies were instructed by Apple to hold off from paying Qualcomm while the patent fight is underway.
While Um admits that it is unlikely that these four Taiwanese will seek direct payment from Apple because the agreements are with the contract manufacturers, it is nonetheless possible that Qualcomm will seek injunctive relief and this could affect Apple’s product shipments. He also adds that Qualcomm could turn on Apple as well on the basis of unlawful interference.
However on the whole the market is very bullish on Apple- it has a Strong Buy analyst consensus with a $163 price target (6.5% upside from the current share price of $153). In the last three months, the stock has received 26 buy, 4 hold and zero sell ratings.
Greenblatt ripped back the fund’s holding in NVIDIA by a massive 94%. Gotham’s current Nvidia shareholding is one of the fund’s smaller stocks and is worth $2.66 million.
Bernstein analyst Stacy Rasgon believes that Nvidia’s stellar performance last year can continue for another year. Rasgon reiterated his buy rating on the stock May 19 with a $165 price target – a price target that is almost $40 above consensus. His bullish attitude towards the stock stems from his calculation that the total addressable market size for the datacenter market could be “huge” due to the advancement of AI and accelerated computing. Consequently, Rasgon is “forecasting 63% annual growth through CY2019” which will take Nvidia to revenue of $3.6 billion.
He told investors to expect volatility but that ultimately the stock is undervalued and the stock should inflect upwards. Investors should appreciate the company’s leadership position in AI, as well as the potential expansion of the company’s automotive business to a multi-billion opportunity within the next decade. Gaming growth above the single-digits can be maintained, the analyst added.
Nvidia has a Moderate Buy analyst consensus rating based on the 11 buy, 6 hold and 3 sell ratings over the last three months. The average analyst price target of $126 is a 7% downside from the current share price of $136.