The 4 Best "Magic Formula" Stocks Today
Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors like a good deal. The problem is, most of us wouldn't know a bargain if it hit us in the face.
At least that's what hedge fund manager and value investing icon Joel Greenblatt says. In a series of books and lectures Greenblatt has touted his "magic formula" for stock picking. Greenblatt argues that by following the simple formula we can take the guess work out of picking bargain stocks.
So what is the magic formula?
I'm glad you asked. Simply put it's the best ranked stocks with a low earnings yield and a high return on capital. By using these two rankings, the formula seeks to find cheap stocks with underlying businesses that are performing well. And while that sounds overly simple, following this simple formula would've helped you trounce the market over many years.
I've looked through the best ranked stocks according to Greenblatt's formula, and these four stocks are amongst the most compelling today.
Drug Store dollars
There was a time when CVS was just a "drug store." But since the 2007 purchase of Caremark, and introduction of the new CVS Caremark (NYSE: CVS), this has been a different company. The combination of these two successful businesses has brought out the best in both of them.
With the addition of Caremark, CVS added a dominant market leader in the pharmacy benefit management and mail order game. This has saved the company money on inventory as pharmacy services and suppliers have been streamlined. In addition, CVS has been spared from the "retailer-PBM" vendor drama and costly negotiations that have hurt Walgreen's earnings in recent years, due to their relationship with Medco.
All this synergy has lead to some strong magic formula numbers; CVS Caremark has an earnings yield of 5.56% and ROC of 7.54%. The companies earnings increased 10%, and the dividend has increased a whopping 23% since the merger.
Who says acquisitions are bad for shareholders?
A dogs life
When it comes to retail stocks, companies that create a unique buyer experience win. PetSmart (NASDAQ: PETM), has successfully branded itself as a unique place to purchase pet products and care for pets. The company ranks amongst the 50 best magic formula stocks, regardless of size, with an earnings yield of 5.45% and ROC of 29.74%.
In addition to creating a great experience, PetSmart is in a very high growth industry. The pet product industry has nearly doubled since 2001, which makes the business of caring for our furry friends a $55 billion behemoth. The growth has been largely because PetSmart has expanded beyond selling pet food and toys, to offering veterinary services, training courses, and more. The growth is just getting started on this one, EPS is expected to increase by nearly $2 per share by 2015.
High flying profits
Expedia (NASDAQ: EXPE) makes our magic formula list, checking in with an earnings yield of 2.23% and ROC of 17.28%. The company is in a unique position because it's in a fast growing industry, but at the same time its business model has relatively low barriers to entry, so there's good and bad. Since Expedia's business landscape is a draw, between good and bad, it makes sense to rely on fundamentals.
Expedia's fundamentals are strong. Revenues have been growing faster than earnings over the past year, and now revenue is projected to grow nearly 40% by 2015. Unlike arch rival Priceline, Expedia also pays a dividend of 0.92%. Sure that dividend is scant, but when you combine it with a fast growing industry and a profitable, high margin, business--the overall investment thesis makes sense.
Best of breed brands
Intuit (NASDAQ: INTU) ranks among the 50 best magic formula stocks as well, with an earnings yield of 4.45% ROC of 38.94% This company earns excellent returns on equity because its businesses are both low yield and hold dominant market share.
If you're not familiar with this company, it provides technology based financial management solutions through signature brands like Quicken, Turbo Tax, and QuickBooks. I can't think of a better sign for a stock than having brands that are both riding strong trends with "best of breed" names.
Intuit's earnings are expected to grow 30% by 2015, and both EPS and revenues have grown at about 10% for five consecutive years. The numbers and the shift of customers wanting more software based financial programs, makes this stock a winner.
It's ok to like a value
Everyone likes a value, but finding them doesn't have to be so hard. What I like best about Joel Greenblatt's "magic formula" is that it provides outstanding returns without making the process cumbersome. It cuts straight to the two most important aspects of buying a stock: the stock's value and (business) performance.
But what it doesn't do is make a smart decision for you; you'll have to do that. In other words, it makes sense to start with the magic formula to screen stocks, but ultimately you'll have to make the call on which stocks to buy.
I like these stocks because not only are they cheap with great past performance, they have a bright outlook going forward. Wouldn't you agree?
Looking for more analysis?
Although you won't find this on the Magic Formula list, it happens to be The Motley Fool's chief investment officer's No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.
Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends Intuit and PetSmart. The Motley Fool owns shares of Intuit. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!