• The First Cut
  • 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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