The publication of fund manager Joel Greenblatt's The Little Book That Beats the Market in 2005 marked a unique point for investors. They now held insights into the investing strategies of a value investing master -- insights that are easily replicated. As proof, Greenblatt has achieved phenomenal results over the past two decades, besting even the performance of Warren Buffett.
His 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 companies with top ratings of four or five stars from Motley Fool CAPS. Combining those rankings with Greenblatt's suggested criteria should help us discover winning investments that may produce 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) |
---|---|---|---|---|
Pacer International |
29% |
>100% |
$9.43 |
***** |
Murphy Oil |
31% |
>100% |
$45.25 |
***** |
Manulife Financial |
23% |
>100% |
$17.55 |
***** |
Silicon Image |
91% |
>100% |
$2.85 |
**** |
The9 |
69% |
>100% |
$14.92 |
***** |
Sources: Capital IQ, 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 rely on this as simply a list of companies to buy. Due diligence on this narrowly focused list of companies is always a smart requirement. Let's see what CAPS members have to say about a couple of these candidates.
A little bit of pixie dust
Chinese online game operator The9 has enjoyed massive success from its massively multiplayer online role-playing game (MMORPG) World of Warcraft, with its revenue experiencing compounded annual growth rates of more than 200% over the past three years. While the stock has fallen over the past year -- losing more ground than NetEase.com
The9's WoW contract renewal with Activision Blizzard
CAPS member directd looks at the market The9 targets, the games it offers, and the mountains of cash it has on the balance sheet -- $326 million and no debt as of the September quarter -- and thinks The9's got game:
Online gaming, WoW, China....what's not to like? Oh yea, incredible cash on hand at a time when cash is king, a great lineup of new games coming up and oh yea a special cash dividend for stockholders of record Feb 1. Great opportunity to get in on a great company with incredible growth potential.
A magical moment
CAPS member howardtepper believes the market is ruling valuations with its heart, not its head -- particularly when it comes to pricing Silicon Image, a semiconductor company that owns intellectual property related to the hi-def HDMI and DVI standards. Its shares trade more than 60% below their 52-week high. howardtepper says:
This market is not related to values but to emotions. When the basis of investing returns to a sound basis this stock will perform on at a normal market level.
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.