Joel Greenblatt (Trades, Portfolio) introduced the individual investing world to the “Magic Formula” when he published his 2005 book, “The Little Book That Beats the Market.” The idea behind the Magic Formula is to apply a simple mathematical formula to find good businesses trading at bargain prices.
The formula ranks companies based on the combination of two metrics: earnings yield and return on capital. As the formula works best when applied to U.S. companies and companies with market caps of at least $100 million, I have eliminated companies that do not meet these criteria from my search. Small-cap and non-U.S. businesses are often structured differently, so being ranked highly by the “Magic Formula” would not indicate that they are good investments. For the same reason, utilities and financial companies are also not considered.
Below are three companies that are undervalued, have a GuruFocus business predictability rating of 3 or more and rank highly on the GuruFucus Magic Formula Screener, a Premium feature based on Greenblatt’s formula.
Sally Beauty Holdings Inc.
One company that ranked highly on the Magic Formula screener was Sally Beauty Holdings Inc. (SBH, Financial). It has an earnings yield of 12.24% (higher than 87.78% of competitors), a return on capital of 51.14% (higher than 87.46% of competitors) and a business predictability rating of 4 out of 5 stars.
Sally Beauty is the world’s largest beauty supply retailer. The Denton, Texas-based company sells products such as salon-quality hair color, nails, makeup, hair treatments and salon equipment.
As of Feb. 12, Sally Beauty has a market cap of $1.55 billion, a price-earnings ratio of 6.16 and a current ratio of 2.55. According to the Peter Lynch chart, shares are currently trading below their fair value.
GuruFocus has assigned the company a financial strength rating of 4 out of 10 and a profitability rating of 9 out of 10. The cash-debt ratio of 0.05 is low, but the company has decreased its debt in recent years, and the Altman Z-Score of 3.44 suggests that it is not in danger of bankruptcy.
Sally Beauty recently reported earnings for its first quarter of fiscal 2020. For the quarter, revenue was $980.21 million, missing analyst estimates by 1.42%, while earnings per share came in at 47 cents, missing expectations of 56 cents.
Over the past three years, Sally Beauty has grown its revenue at a rate of 6.7% per year and its earnings per share without non-recurring items at a rate of 14.6% per year.
Brick-and-mortar sales for the company continue to lose ground compared to online sales. The quarter saw global e-commerce sales increase by 27.6% compared to the prior-year quarter, while same-store sales were down 0.3%.
In response to the shifting market preferences, the company is in the process of transitioning to an omni-channel retailer. It recently introduced ColorView in stores and in its app, which allows customers to use selfies to “try on” makeup and hair dye, as well as same-day delivery for online orders.
Biogen Inc.
One company that ranked highly on the Magic Formula screening was Biogen Inc. (BIIB, Financial). It has an earnings yield of 12.32% (higher than 88.03% of competitors), a return on capital of 153.25% (higher than 96.75% of competitors) and a business predictability ranking of five out of five stars.
Biogen is a neuroscience pioneer based in Cambridge, Massachusetts. The biotech company researches and develops therapies for neurological and neurodegenerative diseases, including multiple sclerosis and leukemia. The science and technology that goes behind the $53 billion company’s product lineup is cutting-edge, which is matched in its high prices.
As of Feb. 12, Biogen has a market cap of $57.52 billion, a price-earnings ratio of 10.52 and a current ratio of 1.72. According to the Peter Lynch chart, shares are trading below their intrinsic value.
GuruFocus has assigned Biogen a financial strength rating of 6 out of 10 and a profitability rating of 10 out of 10. The cash-debt ratio 0.7, debt-to-equity ratio of 0.48 and equity-to-asset ratio of 0.49 are around the industry averages.
Before the market opened on Jan. 30, Biogen reported its fourth-quarter and full-year earnings for 2019. For the fourth quarter, it reported earnings per share of $8.34, beating analyst estimates of $8 and rising 19% year over year. Revenue was $3.67 billion and net income was $1.43 billion, compared to $3.52 billion and $944 million in the prior-year quarter.
Revenue for the full year came in at $14.37 billion, up 7% compared to 2018, while GAAP earnings per share came in at $31.42, a 46% increase from 2018.
Over the past three years, Biogen has grown its revenue at a rate of 12.1% per year and its earnings per share without non-recurring items at a rate of 12% per year.
Biogen’s revenue growth was primarily driven by increases in product sales. Overall revenue increased 4%. Among Biogen’s drugs, the top growers are biosimilars (up 35% year over year), Spinraza (up 22%) and Tecfidera (up 5% year over year).
“Our pipeline has grown and is maturing, as we added 7 new clinical programs in 2019 and expect 11 mid- to late-stage data readouts by the end of 2021,” CEO Michel Vounatsos said in the fourth-quarter earnings report. “We look forward to multiple near-term opportunities for value creation, including in Alzheimer’s disease, ALS, stroke, lupus, ophthalmology, and biosimilars, as we aim to build a multi-franchise portfolio. Across all areas of investment, we remain focused on diligent capital allocation to maximize returns for our shareholders over the long term.”
NetApp Inc.
NetApp Inc. (NTAP, Financial) also ranked highly on the Magic Formula screener. The company has an earnings yield of 9.58% (higher than 76.46% of competitors), a return on capital of 144.47% (higher than 97.37% of competitors) and a business predictability rating of three out of five stars.
NetApp is a tech company headquartered in Sunnyvale, California. It provides hybrid cloud data services and data management and has ranked in the Fortune 500 ever since it got into the cloud business in 2012.
As of Feb. 12, NetApp has a market cap of $13.71 billion, a price-earnings ratio of 14.95 and a current ratio of 1.31. According to the Peter Lynch chart, shares are slightly undervalued.
NetApp has a GuruFocus financial strength rating of 6 out of 10 and a profitability rating of 9 out of 10. The company’s equity-to-asset ratio of 0.07 and debt-to-equity ratio of 3.35 are not favorable, but operations are supported by a cash-debt ratio of 1.67.
NetApp released results for its third quarter of fiscal 2020 on Feb. 12 after market close. The company reported revenue of $1.4 billion and non-GAAP earnings per share of $1.16, both slightly lower than analyst expectations of $1.46 billion in revenue and $1.19 in earnings per share.
Over the past three years, NetApp has grown its revenue at a rate of 8.3% per year and its earnings per share without non-recurring items at a rate of 80.3% per year.
The company faced stiff competition when giants such as Amazon.com (AMZN, Financial) and Microsoft (MSFT, Financial) developed their own public cloud-based storage offerings beginning in 2015. This market shift poses threats to enterprise storage providers such as NetApp, as their lower research budgets can make it difficult to keep ahead of the game in terms of innovation.
After George Kurian became NetApp’s CEO in 2015, the company’s earnings began to recover and it entered several new profitable data spaces. Recently, the enterprise storage market has been in a decline due to slowing global economic growth, and NetApp is no exception; revenue for the past three quarters has been lower than it was for the first three quarters of fiscal 2019. This has caused investors to be bearish on the stock, though, as always, it is difficult to predict where prices for the fast-changing tech sector will go next.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
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