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Magic Formula Stocks

by John Bajkowski

Magic Formula Stocks Splash image

Successful investment approaches can be simple or complex. In “The Little Book That Beats the Market” (John Wiley & Sons, Inc., 2006, www.magicformula
investing.com
), Joel Greenblatt presents the “Magic Formula” investment approach that relies on two simple rules: seek out good companies with a high return on invested capital that can be purchased at a low price that provides a high pretax earnings yield.

Greenblatt measures the strength of a business by examining its return on capital, which he defines as operating profit (EBIT, earnings before interest and taxes) divided by tangible investment capital (net working capital plus net fixed assets). Stocks passing the First Cut have a return on invested capital of 25% or higher. If you do not have access to this variable, Greenblatt suggests that investors use return on assets (net income divided by assets).

To help value a business, Greenblatt takes the price-earnings ratio, inverts it and tweaks the variables slightly. Greenblatt calculates earnings yield by dividing operating earnings EBIT by the enterprise value. The enterprise value tries to reflect the minimum value to purchase a company outright. It is calculated by adding market capitalization, preferred stock, and total debt and subtracting excess cash. Stocks passing the First Cut have a minimum EBIT to enterprise value earnings yield of 25%. As a substitute, Greenblatt notes that you can look for low price-earnings ratios, but warns of avoiding firms with extremely low ratios because earnings may be unusual in some way.

Stocks that made this issue’s First Cut are also domestic, exchange-listed stocks with a minimum share price of $5.00 and a market capitalization of at least $50 million. Greenblatt also excludes financials and utilities because of their unique financial structures. Greenblatt suggests building a 20- to 30-stock portfolio by selecting five to seven stocks every two to three months.

 

Company (Exchange: Ticker) EBIT/
Enterprise
Value
(%)
Return
on
Capital
(%)
Price-
Earnings
Ratio
(X)
Return
on
Assets
(%)
Market
Cap
($ Mil)
Liab
to
Assets
(%)
Price Change
13-Wk
(%)
52-Wk
(%)
Share
Price
(4/17)
($)
 
 
 
Description
i2 Technologies, Inc. (M: ITWO) 90.3 45.7 2.0 37.6 177 58.5 31 -19 8.07 supply mgmt servs
United States Steel (N: X) 50.9 74.8 1.7 12.6 3481 69.6 -8 -81 29.96 steel producer
Genesco Inc. (N: GCO) 49.2 92.5 3.4 18.1 410 45.4 42 7 21.35 branded footwear
Innophos Holdings, Inc. (M: IPHS) 48.3 79.7 1.4 31.5 286 66.7 -26 -24 13.54 specialty phosphates
Dawson Geophysical (M: DWSN) 45.8 70.3 4.0 15.1 139 17.6 13 -76 17.87 seismic data servs
HLTH Corporation (M: HLTH) 42.1 71.5 5.6 28.2 1209 69.4 13 12 11.74 health info servs
Olympic Steel, Inc. (M: ZEUS) 40.4 40.2 3.4 13.7 228 31.9 19 -56 21.03 steel serv center
Insteel Industries, Inc. (M: IIIN) 39.0 56.8 4.0 16.3 136 14.7 -20 -32 7.75 steel wire reinforcing
Ceradyne, Inc. (M: CRDN) 39.0 45.3 5.0 12.7 516 26.5 -17 -41 19.98 tech ceramic prods
KBR, Inc. (N: KBR) 38.7 30.7 8.8 5.9 2612 65.1 2 -47 16.24 engineer & construct
CF Industries Holdings (N: CF) 38.1 90.6 5.7 25.6 3386 44.0 44 -54 69.95 fertilizers
Terra Industries Inc. (N: TRA) 36.7 70.7 4.6 29.8 2811 49.8 38 -38 28.19 nitrogen prods
Lufkin Industries, Inc. (M: LUFK) 34.1 37.2 5.9 15.3 477 22.0 -11 -58 32.08 oilfield prods
ePlus Inc. (M: PLUS) 33.8 27.5 6.9 3.9 96 53.3 15 -10 11.99 software & consulting
Gulf Island Fabrication (M: GIFI) 32.9 43.3 5.0 8.6 144 27.6 -23 -72 10.09 drilling platforms
Rowan Companies, Inc. (N: RDC) 32.6 63.9 4.2 10.1 1809 41.5 16 -61 15.99 drilling servs
Wright Express Corp. (N: WXS) 30.7 68.9 6.1 6.3 754 81.1 64 -41 19.67 pay process servs
Bolt Technology Corp. (M: BOLT) 30.3 38.5 6.6 26.1 81 7.6 39 -62 9.38 oilfield servs equip
Spartan Motors, Inc. (M: SPAR) 29.5 43.6 5.0 13.8 215 34.7 39 -15 6.59 custom vehicles
Allegheny Technologies (N: ATI) 29.3 53.4 5.2 13.2 2891 53.0 12 -61 29.50 specialty metals
EarthLink, Inc. (M: ELNK) 29.3 32.9 4.1 23.6 794 47.0 -3 -8 7.29 Internet service provider
Foster Wheeler AG (M: FWLT) 29.2 47.4 5.9 15.3 2753 86.7 -10 -65 21.78 engineer & construct
Gentiva Health Services (M: GTIV) 28.8 76.7 3.0 16.1 454 49.2 -42 -27 15.58 home health servs
Michael Baker Corp. (A: BKR) 27.8 41.9 7.9 10.1 231 51.1 -35 17 26.03 engineer & energy servs
WABCO Holdings Inc. (N: WBC) 27.6 32.2 5.1 11.0 1054 66.1 0 -63 16.48 electromech prods
Oil States International (N: OIS) 27.5 41.6 4.4 10.3 928 47.0 -4 -61 18.72 oil & gas prods & servs
Hawk Corporation (A: HWK) 26.8 30.9 5.0 8.9 105 67.8 -32 -32 12.05 friction prods
OM Group, Inc. (N: OMG) 26.8 26.6 6.4 15.9 861 21.2 44 -52 28.01 specialty chemicals
Versant Corporation (M: VSNT) 25.9 32.6 7.6 21.4 62 16.7 7 -41 17.00 data mgmt software
Chart Industries, Inc. (M: GTLS) 25.8 41.5 3.9 8.8 303 55.6 18 -74 10.67 equip for indus gases

 

Data Category Field Operator Factor Compare To
Price and Share Statistics Price >   5
Company Information Exchange  Not Equal   Over the Counter
Company Information ADR/ADS Stock Is False    
Company Information Sector Not Equal   Utilities
Company Information Sector Not Equal   Financial
Company Information Country Equals   United States
Price and Share Statistics Market Cap >=   50
  Enterprise Value* >   0
  Magic EBIT* >   0
  Magic Tagible Capital* >   0
  Magic Return on Capital* >   25
  Magic EBIT to Enterprise Value* >   25
         
Custom Field Name Formula
Enterprise Value [Market Cap Q1] + [Long-term debt Q1] + [Preferred stock Q1] + [Short-term debt Q1] - [Cash Q1]
Magic EBIT [Pre-tax income 12m] + IIF(IsFieldNull ( [Interest expense 12m] ) =0,0, [Interest expense 12m] )
Magic EBIT to Enterprise Value (IIF( [Magic EBIT]>0, [Magic EBIT], null) / IIF( [Enterprise Value]>0, [Enterprise Value], null))*100
Magic Tangible Capital [Accounts receivable Q1] + [Inventory Q1] + [Cash Q1] - [Accounts payable Q1] + [Net fixed assets Q1]
Magic Return on Capital (IIF( [Magic EBIT]>0, [Magic EBIT], null) / IIF( [Magic Tangible Capital]>0, [Magic Tangible Capital], null))*100
 
John Bajkowski is president of AAII.


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