If you want to increase your chances to beat the market, one method is to screen for stocks that rank highly on the "Magic Formula" criteria.
About the Magic Formula
Created by Joel Greenblatt, a famous value investor and author of "The Little Book That Still Beats the Market," the Magic Formula ranks stocks based on a specific set of technical criteria that are described in the book. The two most significant components of the ranking are their earnings yield and return on capital.
In his book, Greenblatt has defined these two financial indicators a little differently. He calculates the earnings yield by dividing earnings before interest and taxes (Ebit) by the enterprise value and the return on capital by dividing Ebit by net fixed assets and working capital. Also, these stocks have a market capitalization of more than $100 million and do not represent equities in financial, utility or non-U.S. companies.
In order to take advantage of specific tax benefits, amid these magic formula stocks, losers are sold one week before they have completed one year of uninterrupted holding, while winners give the portfolio space to new stocks one week after the one year mark.
According to Greenblatt's book, the entire process must be repeated each year for at least five years to have a high likelihood to beat the S&P 500 index (a benchmark for the stock market). This estimate is based on the results of past backtesting activities which were conducted to assess the approach.
Below are three of my stock picks that rank highly on the GuruFocus Magic Formula screener.
AMC Networks Inc
The first stock to consider is AMC Networks Inc (AMCX, Financial), a New York-based entertainment TV company.
The stock price traded at $23.28 per share at close on Oct. 16 for a market capitalization of approximately $1.21 billion, an earnings yield of 12.7% and a return on capital ratio of 31.9%.
AMC Networks Inc's earnings yield ranks better than 74% of competitors, while its return on capital ratio ranks better than 79% of companies operating in the media – diversified industry.
The share price has fallen by 51% over the past year and represents a more than 30% discount to the middle point of the 52-week range of $19.62 to $49.10.
AMC Networks Inc does not pay dividends.
GuruFocus has assigned a score of 4 out of 10 for the financial strength rating and of 9 out of 10 for the profitability rating of the company.
As of October, seven out of 19 sell side analysts on Wall Street recommend buying the stock. The average target price is $25.88 per share.
GrafTech International Ltd
The second stock to consider is GrafTech International Ltd (EAF, Financial), a Brooklyn Heights, Ohio-based global manufacturer and seller of graphite electrodes and petroleum needle coke-based electrodes.
The stock price closed at $7.09 per share on Oct. 16 for a market capitalization of nearly $1.9 billion, an earnings yield of 21.6% and a return on capital ratio of 84%.
GrafTech International Ltd's earnings yield ranks higher than 90% of competitors, while the return on capital ratio ranks better than 97% of companies operating in the industrial products industry.
The share price has declined by 38.8% over the past year and represents a 30.5% discount to the middle point of the 52-week range of $5.56 to $14.84.
Currently, GrafTech International Ltd pays dividends at a pace of 1 cent per common share each quarter, yielding 0.56% in terms of forward dividend yield as of Friday.
GuruFocus has assigned a score of 4 out of 10 for the financial strength rating and of 5 out of 10 for the profitability rating of the company.
As of October, the stock has an average buy recommendation rating on Wall Street with a target price of $9.13 per share.
Perdoceo Education Corp
The third stock to consider is Perdoceo Education Corp (PRDO, Financial), a Schaumburg, Illinois-based provider of education and training services to U.S. students in various career-oriented disciplines through online and other learning programs.
The stock price was trading at $12.16 per share at close on Oct. 16 for a market capitalization of $840.63 million, an earnings yield of 24.5% and a return on capital ratio of 180.6%.
Perdoceo Education Corp's earnings yield ranks better than 92% of competitors, while the return on capital ratio ranks better than 92% of companies operating in the education industry.
The share price has fallen by 17.6% over the past year and represents a nearly 10% discount to the middle point of the 52-week range of $7.11 to $19.85.
Perdoceo Education Corp does not pay dividends.
GuruFocus has assigned a score of 9 out of 10 for the financial strength rating and of 4 out of 10 for the profitability rating of the company.
As of September, three out of three sell side analysts on Wall Street recommend to buy the stock. The average target price was $22.67 per share.
Disclosure: I have no position in any security mentioned in this article.
Read more here:
- 3 Stocks Growing Capex Fast
- 3 Fast-Growing Small Caps to Consider
- 3 Stocks Trading Below the Intrinsic Value
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