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 investing strategies that a value investing master himself used and that are also easily replicated. 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 those companies with top ratings of four or five stars from Motley Fool CAPS.

Over the first 20 months of compiling the collective intelligence database, it was found that newly minted five-star stocks offered the best opportunities for investors, whereas the lowest-rated companies fared the worst. 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:

Source: CapitalIQ, a division of Standard & Poor's; Motley Fool CAPS. Pre-tax earnings yield is inverse of EV/EBIT. Pre-tax ROC is EBIT divided by tangible capital employed.

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

A little bit of pixie dust
Providing the technology to shrink the chip packaging for cell phones, digital cameras, and computers has given Tessera Technologies a profitable niche in which to play. As CAPS member TMFPlatoish notes, most of the industry's top players acknowledge its patents and are willing to pay the royalty fees that go with it.

The original business has to do with patented packaging technology. Most serious players have acknowledged the patents and technology and pay a few pennies per devices shipped. Not all though, especially the second source Taiwan players. This is all under litigation currently. Still, they get about 75% of the business and that will go higher.

Amkor Technology (NASDAQ:AMKR) found out it might have just been easier to go with the program, as it lost a $60 million judgment to Tessera for breaching its license agreements. Others, such as Motorola (NYSE:MOT), have signed on to license the technology with the option to pay royalties in the future.

Stealing opportunities
Housing certainly looks moribund, and with home prices plunging still, it doesn't look like it will get better anytime soon. According to the most recent Standard & Poor's/Case-Shiller index, home prices in 20 metropolitan areas were down 18% in November, with Phoenix recording the worst drop, at 33%. Yet some see the jump in home sales in December as a hopeful sign that housing is turning the corner, which may bode well for NVR.

CAPS All-Star member floridabuilder2 thinks those who are betting against Reston, VA-based homebuilder NVR are doing it for the wrong reasons. Whereas he's given the red thumb to most builders, he sees NVR as being best-in-class. Some analysts might agree, considering its exposure to healthier real-estate markets, including Texas and Salt Lake City.

If you are red-thumbing NVR because you hate all builders, red thumb away. If you are red-thumbing NVR because you think the company is in trouble or is not run well.... you are barking up the wrong tree.

NVR is best in class in the industry. Don't bite into the only apple with a worm in it.

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 can still save the day. 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.