This Magic Formula embodies the following basic principles: Look for high ROC and high earnings yield; figure out what "normalized earnings" will be 3-4 years into the future; make sure the stock is very cheap based on normalized earnings. He considers that it is worth concentrating in investing in 5 to 8 securities, which can make up 80% of his portfolio. One position could be as high as 30%.
Least but not last, he is also the author of two investment books, including Joel Greenblatt: The little Book that Beats the Market.
Frank Voisin of Valuentum has said at an article written for US Today: “We actually tested his short track record and determined that Greenblatt’s strategy has true onset, even when we account for style and risk factors such as size, value, and momentum effects. We like Greenblatt because he is not secretive about his investment style. Instead, he shares his strategies and opinions with the public and encourages others to do so. His Magic Formula investment strategy produced back-tested returns of 30.8% annually from 1988 to 2004, more than doubling the 12.4% return of S&P 500 during the period. His actual performance is also beating the market. We believe that by focusing on Greenblatt’s best stock picks, investors will be able to outperform the market in the long term.”
I found very compelling to research stocks that trade at a very low P/E and adapts to the Magic Formula Joel invented:
ITT Corp (NYSE:ITT): Greenblatt INCREASED his position last quarter
With a P/E of 2.9 that makes it very attractive, ITT Corporation retains the leftover industrials businesses of the pre-split ITT, as well as the company name and ticker. The company is engaged in manufacturing a diverse collection of highly engineered industrial products and provides high-tech solutions from its four segments: industrial process (accounting for 37% of revenue), motion technologies (accounting for 28%), interconnect solutions (accounting for 21%), and control technologies (accounting for 14%). About 30% of revenue and 60% of operating income come from aftermarket sales. Europe and emerging markets constitute about 37% and 25% of sales, respectively. ITT is well positioned in these markets.
ITT's financial health is strong and should easily support management's plans to increase revenue an additional 2-3% annually from acquisitions of companies with $15 million-$50 million of annual revenue. Acquisitions of such size are less competitive to bid, can be acquired at lower multiples, and are easier to digest and extract value.
The company's highly engineered products are sticky with customers and help the firm generate low- to mid-teens operating margins and mid-teens returns on invested capital.
Career Education Corporation (NASDAQ:CECO): Greenblatt REDUCED the position last quarter
With a P/E of 3.72, Career Education Corporation is a provider of private, for-profit post-secondary education with campuses throughout the United States and Canada, the United Kingdom and the United Arab Emirates. Their schools enjoy long operating histories and offer a variety of master's degree, bachelor's degree, associate degree, and diploma programs in career-oriented disciplines. They offer educational programs principally in the following four career-related fields of study, Visual Communication and Design Technologies, Information Technology, Business Studies, and Culinary Arts.
In the last quarter the company earned operating income of $16 million. As of September 30, 2011, it has cash, cash equivalents and short-term investments of $449 million. Cash flow from operations was approximately $200 million. Cash expenditures in the 9 months of the year were $68 million or 4.6% of revenue. In the third quarter, the company repurchased 300,000 shares of our common stock for approximately $7 million.
Gentiva Health Services, Inc. (NASDAQ:GTIV): Greenblatt INCREASED his position last quarter
Gentiva Health Services, Inc. provides home health services and hospice care in the United States. The company offers skilled nursing and therapy services, paraprofessional nursing services, and homemaker services primarily to adult and elderly patients through licensed and Medicare-certified agencies. Its P/E has been at 3.61.
Unfortunately, GTIV has been absolutely decimated and is currently trading at a 9% low as a result of a steady barrage of potentially negative news headlines. The primary overhang for GTIV over the past few months steamed from fears of the CMS making greater than expected reimbursement cuts in 2012, the Senate Finance Committee inquiry into Medicare reimbursement rates in the home health industry, and the uncertainty surrounding the actions of the Congressional Joint Committee as they pursue the budget cuts required by the debt ceiling deal.
Research In Motion Limited (RIMM): Greenblatt REDUCED his position last quarter
Research in Motion designs and markets wireless handsets, software, and services. RIM's primary revenue driver is the sale of handsets to carriers worldwide that promote the company's BlackBerry line of devices. In addition, RIM generates access service fees from carriers for each BlackBerry subscriber. Software licensing revenue is also generated from corporate clients incorporating the BlackBerry enterprise server software in their wireless data management.
RIM is financially strong from the balance sheet standpoint, with $1.4 billion in cash and investments against no debt and a P/E of 3.06. Sales outside North America now account for more than 50% of RIM's revenue.
The BlackBerry is still the gold standard in certain corporate markets where premium security is valued.
Momenta Pharmaceuticals, Inc.(NASDAQ:MNTA): Greenblatt INITIATED A NEW POSITION last quarter
Momenta Pharmaceuticals, Inc. is a biotechnology company specializing in the detailed structural analysis and design of complex sugars for the development of improved versions of existing drugs, the development of novel drugs and the discovery of new biological processes. Momenta is also utilizing its ability to sequence sugars to create technology-enabled generic products.
Last quarter was very strong. First, from a financial standpoint, it reported that net income for the quarter exceeded $60 million. EPS were $1.18 and at quarter’s end, it had a cash balance of $308 million and $85 million in accounts receivable. Least but not last, its P/E is at 3.77, which turns it into an interesting pick.