If you want to increase your likelihood to beat the market, one method is to select stocks that rank highly on the "Magic Formula" criteria.
About the Magic Formula
The Magic Formula was created by Joel Greenblatt, a prominent value investor and author of one of the most succesful books on investing in stock markets, titled "The Little Book That Still Beats the Market." The Magic Formula makes a ranking of stocks based on specific technical criteria that are described in the book. The two most significant criteria of the ranking are high values of the earnings yield and return on capital.
In his book, Greenblatt has assembled these two financial ratios a little differently. The earnings yield is calculated by dividing earnings before interest and taxes (Ebit) by the enterprise value, while the return on capital by dividing Ebit by net fixed assets and working capital. Furthermore, these stocks have a market capitalization of no less than $100 million and do not represent equities in financial, utilities or non-U.S. companies.
In order to take advantage of specific tax benefits, magic formula stock losers are sold one week before the one year mark of uninterrupted holding, while magic formula stocks winners are sold one week after the one year mark, giving space to new entries.
Greenblatt's book also explains that the entire process must be rerun each year for not less than five years to have a greater likelihood to beat the S&P 500 index. This estimate is based on the results of past backtesting activities that were conducted to evaluate the approach.
Below are three of my stock picks that rank highly on the GuruFocus Magic Formula screener, a screener based on the Magic Formula criteria.
ViacomCBS Inc
The first stock that investors should consider is Viacom CBS Inc (VIAC, Financial), a New York-based global media and entertainment company.
The stock price traded at $29.05 per share at close on Nov. 9 for a market capitalization of $18.01 billion, an earnings yield of 8.08% and a return on capital ratio of 50.86%.
Viacom CBS Inc's earnings yield ranks higher than 77% of companies operating in the media – diversified industry, while its return on capital ratio ranks higher than 81.2% of competitors.
The share price has fallen by 25.84% over the past year and places nearly 10% above the middle point of the 52-week range of $10.10 to $43.04.
Viacom CBS Inc is currently paying quarterly cash dividends to its shareholders with the next one scheduled to be paid on Jan. 4, 2021, producing a forward dividend yield of 3.3% as of Nov. 9.
GuruFocus has assigned a score of 4 out of 10 for the financial strength rating and of 8 out of 10 for the profitability rating of the company.
On Wall Street, the stock has a median recommendation rating of overweight and an average target price of $29.54 per share.
Omnicom Group Inc
The second stock that qualifies is Omnicom Group Inc (OMC, Financial), a New York-based advertising agency that provides corporations with advertising, marketing and communication services.
The stock price closed at $55.49 per share on Nov. 9 for a market capitalization of $11.93 billion, an earnings yield of 10.49% and a return on capital ratio of 85.3%.
Omnicom Group Inc's earnings yield ranks higher than 82.6% of companies operating in the media – diversified industry, while the return on capital ratio ranks better than 87.6% of companies operating in the industry.
The share price has declined by almost 30% over the past year and represents a 12.8% discount to the middle point of the 52-week range of $44.50 to $82.73.
Currently, Omnicom Group Inc pays quarterly cash dividends to its shareholders, with the last payment of 65 cents per share issued on Oct. 12, producing a trailing 12-month dividend yield of 4.69% as of Nov. 9.
GuruFocus has assigned a score of 4 out of 10 for the financial strength rating and of 8 out of 10 for the profitability rating of the company.
On Wall Street, the stock has a median recommendation rating of hold and an average target price of $57.36 per share.
The Interpublic Group of Companies Inc
The third stock that makes the cut is The Interpublic Group of Companies Inc (IPG, Financial), a New York-based provider of advertising and marketing services worldwide.
The stock price was trading at $21.09 per share at close on Nov. 9 for a market capitalization of $8.23 billion, an earnings yield of 6.56% and a return on capital ratio of 35.56%.
The Interpublic Group of Companies Inc's earnings yield ranks better than 73% of companies operating in the media – diversified industry, while the return on capital ratio ranks better than 75% of competitors.
The share price has fallen by 6.3% over the past year, trading about 14.5% above the middle point of the 52-week range of $11.63 to $25.20.
Currently, The Interpublic Group of Companies Inc pays quarterly cash dividends of 25.5 cents per common share, with the most recent payment made on Sept. 15, producing a trailing 12-month dividend of 4.74% as of Nov. 9.
GuruFocus has assigned a score of 4 out of 10 for the financial strength rating and of 7 out of 10 for the profitability rating of the company.
On Wall Street, the stock has a median recommendation rating of overweight and an average target price of $21.95 per share.
Disclosure: I have no position in any security mentioned in this article.
Read more here:
- A Trio of Stocks Trading Below Intrinsic Value
- A Trio of Stock Picks for the 'Buy and Hold' Approach
- 3 Capital-Intensive Stocks to Consider
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