5 Stocks With a Little Magic

When fund manager Joel Greenblatt published his 2005 investing tome, The Little Book That Beats the Market, it marked a unique point for investors. They now held in their hands a collection of investing-strategy insights that a value-investing master himself had used. Even better, the strategies were easily replicated.

The approach is deceptively simple: Buy undervalued, high-performing companies, and hold for a year. Wash, rinse, and repeat. Greenblatt has achieved phenomenal results over the past two decades with that formula. He's even beaten Warren Buffett's performance during that time frame.

But what if we could augment Greenblatt's methodology? Below, we've used a "magic formula" of sorts. Our screen approximates the criteria for pre-tax earnings and return on capital that Greenblatt lays out, but we add to it the ratings from our Motley Fool CAPS investor-intelligence database. Combining those rankings with Greenblatt's guideposts should give us some winning investments that may just produce some outsized returns.

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

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 look at the information in this table 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
Sometimes the market isn't as manic as you'd expect it to be. Take American Physicians Service Group, which provides liability-insurance services for doctors, primarily in Texas. It also offers financial services, such as investment and brokerage services, to institutions and individuals.

Let's see: insurance and financial services, seemingly two of the worst businesses to be in these days. Over the past year, the Insurance tag at CAPS has performed nearly as poorly as the overall market, down 26% compared with a loss of 30% for the S&P 500. And despite a surprising 2% increase in Financials over that period of time, Citigroup (NYSE:C) and Bank of America (NYSE:BAC) make their industry seem as rickety as it ever has. American Physicians, however, has held its own remaining essentially flat over that same time frame.

More importantly, perhaps, is that the company's current valuation offers investors an attractive price. It sports a cheap enterprise value-to-free cash flow ratio of just 5.6. Considering that its 15% return on equity shows that it knows how to be profitable, all the while remaining debt free -- it carries $6.5 million in preferred stock on its balance sheet -- American Physicians looks like a stock that's ready for liftoff.

Highly rated CAPS All-Star member Har1en thought the company might be a real-money pick because of its financial soundness. That echoes the thoughts of bohlmanch, who picked it to outperform the market back in November because it was wickedly stable.

Company has completely avoided subprime mess having as only questionable securities of approximately 2% of total portfolio in Alt-A investments. Just posted 36% YOY earnings growth in last quarter and is buying own stock on the downturn. This stock has been hit along with other financial and insurance stocks, but in the case of this particular stock the drop appears to be nothing more than a warranted correction. A five year chart puts this stock at this time right about in line with its historic trajectory. It had been getting slightly hyperbolic prior to correcting. Right now at 1.03 times book value it may represent one of the safest combinations of growth and value in the small cap universe. Current market cap is $135 mil. AMPHs conservative risk profile has been proven out in the wickedest of financial storms.

Beat the street
Although Greenblatt has provided an interesting magic formula, you'll need to read more than a few pages of his 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 you're 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.