These 5 Stocks Have 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 had in their hands insights into investing strategies that a value-investing master himself used and are also easily replicated. Greenblatt has achieved phenomenal results over the past two decades -- he's even beaten Warren Buffett's performance.

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 criteria for pre-tax earnings and return on capital that he lays out, but we add to it the ratings from our Motley Fool CAPS investor-intelligence database. Combining those rankings with Greenblatt's methodology 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.

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.

We don't think you should just 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. So let's see what CAPS members have to say about these magical companies.

A little bit of pixie dust
No, you weren't dreaming. The market slammed pharmaceutical Sepracor after it announced that the FDA had stopped two of its studies for the insomnia treatment Lunesta. The halt of the studies is likely to hinder the company's ability to extend its patent on the drug by marketing it to children. The one-two punch was a nightmare for the stock, which immediately careened downward 18% on the news. However, investors were more dreamy a few weeks earlier over its subsequent earnings report, which handily beat analyst expectations. The stock has since recovered much of its lost ground.

Still, for Sepracor, Lunesta is a key drug from which the company derives nearly half its revenue. It's also set to lose patent protection on the sleep aid in 2012, so extending the brand to children is an important component of the pharma's strategy, and it helps explain why the market reacted as it did. Yet the FDA's action wasn't related to any data from the clinical trials, nor does it affect sales to adults, the company said. But the FDA did question the relevance of the Sepracor's non-clinical studies. Sales of Lunesta were flat in 2008, at $600 million, but they rose by 2% in the latest quarter, as the drug's sales team was realigned.

Sepracor also has a number of other drugs that enjoyed increased sales in the recently reported quarter, though royalties from outlicensed drugs -- such as Clarinex from Schering-Plough (NYSE:SPG) and Allegra from sanofi-aventis (NYSE:SNY) -- fell by 11% year over year.

Earlier this year, CAPS member FitzColinGerald thought Sepracor's portfolio of drugs served as a solid foundation for future growth.

Although recently burdened by research and development (R&D) costs, Sepracor has a significant upside with its growth prospects. Drugs like Xopenex, Lunesta, and Brovana have given the company a firm revenue stream. Management has been cutting overhead costs, which should free up more money for clinical trials. The key question for Sepracor will be seeing how its pipeline drugs perform over the next few years. With FDA approval, there is no telling how high the market will take its share price.

Emergency service
Ambulatory-surgery-center operator AmSurg depends primarily on a single service -- gastroenterology procedures, which account for about three-quarters of the procedures it performs. With a third of revenue directly tied to reimbursements from government health-care programs such as Medicare, however, there's some risk involved. Over the past few years, the company has been subject to several downward revisions on its Medicare reimbursement rates, a trend that has caused AmSurg's earnings to take a hit. With cost-containment of health care a continuing concern in Washington, the potential for further reductions remains a definite possibility.

In the latest quarter, AmSurg was able to beat analyst expectations, as the volume of procedures jumped by 12% and the company opened 21 new surgical centers. However, while the CAPS Health Care Providers & Services sector tag rose by more than 6% in the past month, AmSurg didn't participate in the rally; its stock fell by 3%. Shares are also down 12% for the year.

Still, 96% of all CAPS members rating AmSurg think it will outperform the market, while 95% of All-Star members have similar expectations.

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 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.