I’m always a little skeptical of any stock market screen called a “magic formula,” but I do like to consult Joel Greenblatt’s screener by that name from time to time.
Greenblatt, who made the screen famous in his book The Little Book that Beats the Market ranks stocks using two criteria:
1. Valuation, as measured by the earnings yield (defined by Greenblatt as EBIT / Enterprise Value)
2. Profitability, as measured by Greenblatt’s preferred metric, Return on Capital
There is really nothing “magical” about it. It’s simply a screen that looks for highly-profitable companies trading at cheap prices. Any good analyst can use the list as a starting point for further research.
With that said, I want to highlight a handful of well-known stocks that made the cut on the screen this week:
As you might expect from any list of stocks on a value screens, all of these companies have “issues.” We all know that Apple’s growth is slowing and that its product lineup isn’t as innovative as it was under Steve Jobs. Cisco and Microsoft have had a hard time adjusting to the mobile era. Coach is struggling from weakness in its core market, “aspirational” middle-class American women. And Smith & Wesson is facing slower sales in the years ahead, as a lot of would-be buying was forward by fears of new government gun control.
Yet all of these companies are wildly profitably, all have very low debt and very little risk of financial distress, and all but Smith & Wesson pay a respectable and growing dividend.
As you rebalance your portfolio in the final months of 2013, give the Magic Formula stocks a look. Over any reasonable investment time horizon, “cheap and profitable” is a winning combination.