These 5 Stocks Have Some 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 strategies that a value investing master himself used that are also easily replicated. As proof, Greenblatt has achieved phenomenal results over the past two decades, beating 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 ratings from our Motley Fool CAPS investor intelligence database. Combining those rankings with the criteria that Greenblatt suggests should give us investments that might just produce some outsized returns.

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

Source: Capital IQ (a division of Standard & Poor's) and Motley Fool CAPS. Pre-tax earnings yield is the inverse of enterprise value / 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 short list of companies is always smart. So, let's see what CAPS members have to say about these magical companies.

A little bit of pixie dust
There's very little, in fact, for Pre-Paid Legal, which markets basic legal advice; some Fools have a problem with selling legal services as if they were Tupperware. There's only a few grains more sprinkled on IT consulting software maker Formula Systems.

A better choice seems to be American Physicians Service Group, which provides liability insurance to doctors, primarily in Texas, and financial services. It's rated four stars. The best ones are EMCOR Group and Graham, our two five-star companies.

The bull case for EMCOR
CAPS member investu suggested back in February that EMCOR's "move into revenue-smoothing, refinery maintenance will make this stock outperform." President Obama's stimulus package, which would add money for critical infrastructure projects, wouldn't hurt, either. (The company does mechanical and electrical construction.)

And EMCOR has held up. CAPS All-Star MikeGi points out that it has been a winner throughout the recession. Although its backlog has dropped because the hospitality and gaming industries have struggled, particularly in Las Vegas, operating income has steadily improved over the recession.

Repositioning itself as a more diverse company has been a big factor. EMCOR acquired five companies in 2008 to expand geographically and in the services it provides, from the refinery maintenance niche to several other areas, including industrial maintenance and fire protection.

Competitors like Jacobs Engineering (NYSE:JEC) have looked to secure international contracts, but EMCOR derives more than 80% of its business from the U.S.

Graham looks to grow
Despite weakness in energy-sector spending, Fools have been upgrading their opinion of Graham, which manufactures vacuum and heat-transfer equipment around the world. Sales in the oil refinery, petrochemical, and power industry segments declined in the latest quarter, particularly in the U.S., but management is expecting to use this industry contraction to gain market share. The company is adding staff to take advantage of others' weakness.

MikeGi also likes Graham because of its strong financial position. Investors have beaten the company down, which might make it an extreme bargain, but with analysts finding signs of optimism at rival Gardner Denver (NYSE:GDI), it looks like Graham has a right to be hopeful, too.

Beat the Street
While he has 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. 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.