5 Magical Stocks

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, strategies 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 basic premise 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 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.

Sources: 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 one of these magical companies.

A little bit of pixie dust
Deckers’ Uggs shoes were forecast to be a fashion flop after just a few years, even as companies like Crocs (NASDAQ:CROX) and Heelys (NASDAQ:HLYS) tried to position themselves as the next must-have fashion footwear, whether for adults or kids. I admit to having sworn off Deckers stock several years ago, despite my own affinity for the uber-comfortable slippers.

While shares of Deckers Outdoors have fallen far below the nosebleed heights they reached last year, sales of the sheepskin boots continue to impress as they find new adherents and bring back tired "soles" to buy more. It’s true that I've bought several pairs of slippers over the years, but just look at my CAPS page, where Deckers remains my worst pick ever.

Where Teva sandals disappointed amid the retail slump, Uggs sales remained robust. Deckers' earnings increased to $12.3 million, or $0.93 a share, up from $11.1 million, or $0.86, for the same period a year ago on the strength of Uggs, which rose 67% in the first quarter. As one wag put it, Uggs "are so over they're hot again." Although it expects a loss in the second quarter, management raised the lower end of its full-year forecast for profits.

CAPS member Wakester0 thinks Deckers Outdoor can see its Teva line trek higher as the summer approaches, with consumers moving to buy more sandals:

Still room to grow, analyst estimates put it at $80 in one year. With summer on the horizon, people tend to get out and do more shopping (and buy shoes for summer, shoes like Teva).

The question that continues to dog Deckers is this: Are Uggs a fad or a necessity? To diehard enthusiasts, it's the latter. Despite a plethora of cheap knockoffs, Uggs has been able to maintain steady growth. Deckers has enjoyed better than 40% average annual revenue growth over the past five years primarily because of Uggs, which represent more than 70% of sales and have grown to be an ever-more-important component of the company's success over time.

Of course, therein lies the risk. Should Uggs ever truly fall out of favor, Deckers' business would collapse. But the naysayers have been predicting that ever since the shoes got an Oprah endorsement, and they continue to sell as strongly as ever.

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.