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April Magic Formula Newsletter Pick: A magic formula stock trading for under 10x earning with a 10% yield

April 14, 2012
The Daily Reckoning

GuruFocus

332 followers
GuruFocus publishes three monthly newsletters. These newsletters are included features for Premium Members. Among these newsletters, Ben Graham: Net-Net Newsletter focuses on net-net stocks that Ben Graham would buy. It is released on the first Friday of each month. The Micro-Cap Magic Formula Newsletter picks companies that have high return on capital and high earnings yield. It is released on the second Friday of each month. The Buffett-Munger Best Bargains Newsletter recommends companies that have high business quality, but traded at undervalued prices. A younger Buffett would buy this kind of companies. It is published on the third Friday of each month.

The authors for Ben Graham: Net-Net Newsletter and Micro-Cap Magic Formula Newsletter put their own money into the newsletter picks in real portfolios on the Mondays after the newsletters are released. Subscribers have the full weekends to digest the pick and they will have the same opportunities to buy these stocks on Mondays.

Joel Greenblatt's magic formula has proven to be one of most popular and successful quantitative screens. By finding stocks with better than average return characteristics selling for below average prices, the screen has proven its ability to outperform the market.

However, the screen has one blind spot — stocks with a market cap under $50 million.

This month's pick is a dominant player in a small but extremely profitable industry. You could almost equate it to the PayPal of its industry, where it matches 100s of buyers and sellers and takes a small piece of each transaction.

The company's network effects have allowed it to grow consistently and profitably over the past few years while throwing of gobs of cash. But despite their outstanding ROIC, huge network, and consistent cash flow, the company trades for under 10x trailing earnings.

However, there could very well be a catalyst on the horizon. Management owns more than 50% of the stock, and in each of the past two years has declared a dividend that would equate to an average yield of almost 10% at today's prices. And the company is trying to organically grow its network into new verticals, which could accelerate their growth and cause their stock price to really take off.

Even without that, though, the company's stock looks much too cheap. Our conservative valuation places a fair value price 80% above today's prices, and even that would prove much too cheap if the company can execute on some of its growth plans.

We will buy this week’s Magic Formula Newsletter pick on Monday, April 16.

Download this month’s Microcap Magic Formula Newsletter.

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