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 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 companies with top ratings of four or five stars from Motley Fool CAPS. 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.


Pre-Tax Earnings Yield %

Pre-Tax Return on Capital %

Recent Stock Price

CAPS Rating (5 stars max.)

Graham (NYSE:GHM)





Martha Stewart Living Omnimedia





NutriSystem (NASDAQ:NTRI)





Pre-Paid Legal Services (NYSE:PPD)





ViroPharma (NASDAQ:VPHM)





Source: 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 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
It's true that layoffs aren't always the answer to economic hard times as the costs will often outweigh the savings a company realizes. But sometimes, particularly for cyclical industries, they can be a necessary precondition to prepare for the next business cycle. That's the situation petrochemical industry equipment manufacturer Graham is finding itself in. It has been enjoying the industry's upside since the cycle began in 2004, but it believes it has now reached its peak and as a result, needs to scale back. It will be laying off 5% of its workforce even as it reported flat earnings on 20% growth in revenues.

By controlling its growth through the boom, it finds itself in a more stable position than does rival Dover (NYSE:DOV), which reported a 35% decline in profits year over year. CAPS member Coyote323 recognizes the cyclical nature of Graham's business but notes that it has been a steady performer for the past decade. Perhaps it will even do well from infrastructure investments.

[1/21/09] Company should do well when infrastructure spending begins. Sells into refinery and power plants as well as an assortment of other areas. P/E of 6, no long term debt, no liquidity problems, very small cap ($108MM) and fairly closely held. Business has had cyclical but steady growth over last 10 years.

A magical moment
The peanut butter recall is becoming a sticky wicket for a number of companies including NutriSystem, which had to recall products made with peanut butter from that contaminated plant. While recalls tend to put a pinch on near-term results -- just ask the toymakers -- NutriSystem has also signed a pact with Costco (NASDAQ:COST) that may just outweigh the effects. The warehouse club becomes the first retailer to sell NutriSystem's food. Actually, consumers will receive a "store value card" from the retailer and can use it to order the diet planner's meals online or over the phone.

CAPS member pcstuck figures that while an economic recession might put a crimp in some sales, the dividend-paying, debt-free company still looks like a sweet meal… er… deal.

Debt free company paying a good dividend. Some people may be cutting back on buying their products due to the economic crunch, but this is trading way to low to not at least take another look.

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.

Costco Wholesale is a Motley Fool Inside Value recommendation. Costco Wholesale is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.