These 5 Stocks Have a Little Magic

When fund manager Joel Greenblatt published his investing tome, The Little Book That Beats the Market, in 2005, it marked a unique point for investors. They now had in their hands insights into easily replicated investing strategies that a value investing master himself used. As proof, Greenblatt has achieved phenomenal results over the past two decades, besting even the performance of Warren Buffett.

The strategy is deceptively simple: Buy undervalued, high-performing companies and hold for a year. Wash, rinse, and repeat. But what if we can augment Greenblatt's methodology? Below we've used a "magic formula"-like screen that approximates the pre-tax earnings and return on capital criteria he lays out, but adds to it the star ratings from our Motley Fool CAPS investor intelligence database. Combining those rankings with the criteria that Greenblatt suggests should give us winning investments that may just produce some outsized returns.

Here are a few companies that showed up when I ran this screen recently.

Stock	Pre-Tax Earnings Yield	Pre-Tax Return on Capital	Recent Stock Price	CAPS Rating (out of 5)
CF Industries (NYSE: CF  )	33%	>100%	$82.12	****
Hawaiian Holdings (NYSE: HA  )	37%	>100%	$7.38	**
Primoris Services (Nasdaq: PRIM  )	23%	>100%	$7.04	****
Primus Guaranty (NYSE: PRS  )	700%	>100%	$4.18	****
Terra Industries (NYSE: TRA  )	21%	>100%	$32.12	*****

Source: Capital IQ (a division of Standard & Poor's) and Motley Fool CAPS.
Pre-tax earnings yield is inverse of EV/EBIT. Pre-tax ROC is EBIT divided by tangible capital employed.EV = enterprise value; EBIT = Earnings before interest and taxes.

Although Greenblatt's strategy is a mechanical one, we don't think you should rely upon this as simply a list of companies to buy. Due diligence on this narrowly focused list is always a smart requirement. So, let's see what CAPS members have to say about these magical companies.

A little bit of pixie dust
The fertilizer industry do-si-do continues unabated, with each of the pursued companies spurning the advances of the pursuer. Terra Industries continues to stave off CF Industries, which in turn rejects the overtures made by Agrium (NYSE: AGU  ) . Yet there's little wonder why these companies are the seeds of an M&A boom.

The fertilizer crowd enjoyed the corn bubble last year. As corn prices soared to more than $6 a bushel, Terra ended up generating 26% compounded growth in revenue over the past two years, while profits soared more than 1,100% during the same period. CF witnessed increases of 39% and 350% in revenue and earnings, respectively. Despite fears that corn prices were unsustainable -- and they were; today a bushel goes for around $3 and change -- farmers ended up planting 2 million acres more of corn than the Agriculture Department forecast back in March.

Terra's stock plunged along with corn, falling from $55 a share all the way down to $11. In fact, all three fertilizer makers took the same trajectory down. Valuations suddenly became a lot more attractive, even though many of the same forces that propelled their stocks higher remained in place.

It could be argued that the coming glut of corn will hurt Terra Industries, CF, and PotashCorp (NYSE: POT  ) , but there's reason to remain hopeful. As farmers plant more corn, fields available for soybeans or wheat might be reduced. Although there was a slight increase in soybean planting this year, yields were lower and supplies remain tight. That suggests higher prices for soybeans, which ought to cause farmers to plant more. Regardless of what's going into the ground, farmers are going to need fertilizer to get them growing.

An oft-cited rationale for fertilizer stocks and one used by CAPS member bud357mag is that the need to feed the world will create demand for fertilizer, but add alternative fuels to the equation and you've got a barn burner on your hands:

All movements indicate a large move to the upside as bio-fuels demand increase across all markets worldwide and food production has to increase to feed the people of the world.

All-Star mrindependent makes a similar argument in favor of CF Industries:

I am a longterm agriculture bull based on world deomgraphics. CF Industries produced nitrogen and phosphate fertilizer. The price is right at 8 times trailing earnings.

Beat the street
While he's provided an interesting magic formula, you'll need to read more than a few pages of Greenblatt's book to make your buy or sell decisions. So start your own research on these stocks on Motley Fool CAPS where your opinion is more than welcome. While there you can read a company's financial reports, scrutinize key data and charts, and examine the comments your fellow investors have made -- all from a stock's CAPS page.