If you want to increase your likelihood of finding stocks that could beat the market, one method is to choose stocks that rank highly on the "Magic Formula" criteria.
The Magic Formula was created by Joel Greenblatt, a prominent value investor and author of one of the most successful books on investing, "The Little Book That Beats the Market." The Magic Formula makes a ranking of businesses, sorting them by specific characteristics that are described in the book. The two most significant criteria of the ranking are the earnings yield and the return on capital.
In Greenblatt's book, these two financial ratios are defined a little differently than normal. Greenblatt computes the earnings yield as earnings before interest and taxes (Ebit) divided by the enterprise value, while the return on capital is Ebit divided by net fixed assets and working capital. In addition to high values in these two ratios, Magic Formula stocks are further narrowed down to be U.S. stocks with a market capitalization surpassing $100 million, as business that do not meet these criteria have different capital structures. The Magic Formula also excludes financial and utility businesses for similar reasons.
Below are three of my stock picks that rank highly on the GuruFocus Magic Formula screener, a screener based on the Magic Formula criteria.
Biogen Inc
The first stock that investors may want to consider is Biogen Inc (BIIB, Financial), a Cambridge, Massachusetts-based drug manufacturer.
The stock price traded at $243.58 per share at close on Dec. 30 for a market capitalization of $37.48 billion, an earnings yield of 13.85% and a return on capital of 92.83%.
Biogen's earnings yield ranks higher than 95% of 1,069 companies operating in the drug manufacturers industry, while its return on capital ratio ranks higher than 98% of competitors.
The share price has fallen by nearly 18% over the past year to trade below the middle point of the 52-week range of $223.25 to $374.99.
Currently, Biogen Inc does not pay dividends.
GuruFocus has assigned a score of 6 out of 10 for the financial strength rating and of 9 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 $290.29 per share.
Gilead Sciences Inc
The second stock that qualifies is Gilead Sciences Inc (GILD, Financial), a Foster City, California-based pharmaceutical drug manufacturer.
The stock price closed at $56.65 per share on Dec. 30 for a market capitalization of $71.01 billion, an earnings yield of 3.21% and a return on capital of 89.70%.
Gilead Sciences' earnings yield ranks higher than 60% of 1,069 companies operating in the drug manufacturers industry, while the return on capital ratio ranks better than 92% of competitors.
The share price has declined by 12.8% over the past year to trade below the middle point of the 52-week range of $56.56 to $85.97.
Currently, Gilead Sciences Inc is paying quarterly cash dividends to its shareholders, with the last payment of 68 cents per share issued on Dec. 30, producing trailing 12-month and forward dividend yields of 4.79% as of Dec. 30.
GuruFocus has assigned a score of 5 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 $71.96 per share.
Deluxe Corp
The third stock that makes the cut is Deluxe Corp (DLX, Financial), a Shoreview, Minnesota-based provider of advertising services to small businesses and financial institutions.
The stock price was trading at $28.21 per share at close on Dec. 30 for a market capitalization of $1.18 billion, an earnings yield of 4.55% and a return on capital ratio of 152.81%.
Deluxe Corp's earnings yield ranks higher than 69% of 960 companies operating in the media - diversified industry, while the return on capital ratio ranks better than 84% of competitors.
The share price has fallen by 43.5% over the past year to trade below the middle point of the 52-week range of $18.90 to $51.44.
Currently, Deluxe Corp pays quarterly cash dividends of 30 cents per common share, with the most recent payment made on Dec. 7 for a trailing 12-month and forward dividend of 4.25% as of Dec. 30.
GuruFocus has assigned a score of 5 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 $38 per share.
Disclosure: I have no position in any security mentioned in this article.
Read more here:
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- 3 Stocks Trading Below the Peter Lynch Earnings Line
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