MAGIC FORMULA STOCKS NEAR 52 WEEK LOWS, FAR FROM 52 WEEK HIGHS

With Magic Formula Investing (MFI), the point is very simple: find good companies (identified by high returns on capital), trading at low prices (high earnings yield). That is really all there is to it. The system's inventor, Joel Greenblatt, had to fill most of the strategy's guidebook, The Little Book that Beats the Market, with basic examples and funny anecdotes just to fill out 200 pages!


What the strategy does not identify is this: is it a good time to buy the stock now? This is always a good question, and one that can possibly be answered with a little of the black art known as technical analysis.


MagicDiligence is mostly interested in fundamental analysis: sustainability of cash flows, competitive position, growth potential, strength of management, financial health, and so forth. Assuming these check out, we should have the fundamentally focused investors on the "buy" side. However, if the chart is not favorable, the sizable number of technically focused investors will not want to buy the stock. To get the greatest gains in a market based system, we want to have the majority of investors (technical and fundamental) on the "buy" side.


The very simplest concept in technical analysis is that of a support and a resistance level. Support simply means a price at which the stock price has not fallen below, meaning that buyers tend to come in and "support" the stock price once it reaches that level. Conversely, resistance is a price at which the stock has not broken through, meaning that investors have "resisted" buying the stock once it reaches this level. In general, technical investors prefer to buy a stock when it trades near the support level, and prefer to sell it once it trades near the resistance level.


There is no hard and fast rule of what constitutes a support and resistance level. It depends really on the time frame and how a chart is interpreted. The target holding period in Magic Formula Investing is one year. So for this article, we will simply look at the 52-week high (resistance) and 52-week low (support) for Magic Formula stocks in the screens covered by MagicDiligence (those are the top 50 over 50 million, top 50 over 1 billion, and top 30 over 3 billion).


For the "downside protection" list, we see the top 10 stocks currently in MFI that trade the closest to their 52-week lows. These stocks, at least in theory, are trading at or below levels that investors have been willing to buy them in the past year, meaning there may be limited downside left in the stock price (all prices at close 7/28/2010):


Downside Protection?

Ticker	Company	52wk Low	Current	Difference
WDC	Western Digital Corp	27.12	27.80	2.50%
MYGN	Myriad Genetics Inc	14.26	14.63	2.60%
MD	Mednax Inc	45.25	46.73	3.30%
PETS	PetMed Express Inc	15.00	15.94	6.30%
AOL	AOL Inc	19.61	20.93	6.70%
CEU	China Education Alliance Inc	3.65	3.90	6.80%
RTN	Raytheon Co.	45.02	48.27	7.20%
DNB	Dun & Bradstreet Corp (The)	65.50	70.38	7.50%
CEPH	Cephalon Inc	53.05	57.62	8.60%
LPS	Lender Processing Services Inc	29.70	32.26	8.60%

On the other hand, we can also look at MFI stocks that are trading the greatest distance under their 52-week highs. Again, at least in theory, these stocks could provide the "greatest upside", given the fact that investors have been willing to pay much more for the shares within the past year. These stocks are:


Upside Potential?

Ticker	Company	52wk High	Current	Difference
UTA	Universal Travel Group	17.20	6.12	181.0%
SMED	Sharps Compliance Corp	13.00	4.67	178.4%
TNDM	Neutral Tandem Inc	34.56	13.15	162.8%
AMED	Amedisys Inc	64.28	25.67	150.4%
CSKI	China Sky One Medical Inc	25.45	10.46	143.3%
VALU	Value Line Inc	33.99	14.52	134.1%
SNTS	Santarus Inc	5.82	2.51	131.9%
DRWI	DragonWave Inc	14.10	6.09	131.5%
IMMU	Immunomedics Inc	7.16	3.17	125.9%
GXDX	Genoptix Inc	39.00	17.40	124.1%

As always, investors should always verify the fundamental factors of a company before even considering buying. Maybe there is a good reason that these stocks are trading close to, or even setting, new 52-week lows. In a best case scenario, we have a stock trading well below its intrinsic fundamental value and also near a level where technically oriented investors have been willing to buy it in the past year.


Disclosure: Steve owns WDC, CEU, CSKI, UTA


Steve Alexander

http://www.magicdiligence.com/