Joel Greenblatt (Trades, Portfolio) introduced the investing world to the “Magic Formula” when he published his 2005 book, “The Little Book That Beats the Market.” The idea behind the Magic Formula is to apply a simple mathematical formula to find profitable businesses that trade at bargain prices.
The formula ranks companies based on the combination of two metrics: earnings yield and return on capital. The earnings yield, which is defined as earnings before interest and taxes (EBIT) divided by enterprise value, measures how much the company earns compared to how much the stock is valued by the market. The return on capital, which is defined as EBIT divided by the sum of net fixed assets and net working capital, measures how much a company earns compared to what it spends to produce those earnings.
As the formula works best when applied to U.S. companies and companies with market caps of at least $100 million, I have eliminated companies that do not meet these criteria from my search. Small-cap and non-U.S. businesses are often structured differently, so being ranked highly by the “Magic Formula” would not indicate that they are good investments. For the same reason, utilities and financial companies are also not considered.
Below are three companies that rank highly according to the criteria measured by the Magic Formula, found using GuruFocus’ Magic Formula screener. These stocks have also been popular buys among gurus recently, with gurus buying them more often and in greater quantities than they have been selling them, which indicates they could represent promising value opportunities.
One company that ranks highly on the Magic Formula screener is Medifast Inc. (NYSE:MED), a company that produces and sells weight loss and health-related products through multi-level marketing, including websites, telemarketing and franchised weight loss clinics. It is based in Baltimore.
The company has an earnings yield of 5.16%, a return on capital of 304.81% and a business predictability rating of 3.5 out of 5 stars.
On Dec. 8, shares of Medifast traded around $202.03 for a market cap of $2.39 billion and a price-earnings ratio of 25.38, which is slightly higher than its 10-year median price-earnings of 21.76. The company has a financial strength rating of 7 out of 10 and a profitability rating of 9 out of 10. According to the GuruFocus Value chart, the stock is fairly valued.
In three out of four of the most recent quarters, a higher number of gurus bought the stock than sold it, as shown in the chart below:
By volume, guru buys of the stock have also exceeded guru sells, though the difference is less pronounced:
The biggest guru shareholder of the stock is Jim Simons (Trades, Portfolio)’ Renaissance Technologies with 8.41% of shares outstanding, followed by Pioneer Investments (Trades, Portfolio) with 0.36% and Lee Ainslie (Trades, Portfolio) with 0.07%.
Medifast operates on a subscription model and focuses on building a “lifetime membership” culture among its customers in order to keep the profits coming. There are two main factors that have contributed to the company’s stellar growth and profitability: 1) its focus on building communities among customers so that they are encouraged to keep buying more products, and 2) the prepackaged meals that provide convenience for those with buys lives who may not have time to cook healthy food themselves.
Another company that ranks highly on the screener is Roper Technologies Inc. (NYSE:ROP). Based in Sarasota, Florida, Roper is a diversified industrial company that provides a range of customized software and engineered products and solutions to customers in global niche markets.
The company has an earnings yield of 4.23%, a return on capital of 1,621.15% and a business predictability rating of 5 out of 5 stars.
On Dec. 8, shares of Roper traded around $416.29 for a market cap of $43.62 billion and a price-earnings ratio of 28.1, which is slightly higher than its 10-year median price-earnings of 25.32. The company has a financial strength rating of 4 out of 10 and a profitability rating of 9 out of 10. According to the GF Value chart, the stock is modestly overvalued.
In the four most recent quarters, a higher number of gurus bought the stock than sold it, as shown in the chart below:
In terms of volume, guru buys of the stock exceeded guru sells in only three out of the four most recent quarters, with the second quarter of 2020 seeing a higher volume of sells even as the number of gurus buying the stock remained high:
Chuck Akre (Trades, Portfolio)’s Akre Capital Management is the largest guru shareholder of the stock with 1.82% of shares outstanding, followed by Ron Baron (Trades, Portfolio) with 0.30% and Frank Sands (Trades, Portfolio) with 0.17%.
Roper’s long-term growth plan depends on the profitable acquisition of niche businesses in high-growth areas, which helps mitigate the costs typically associated with the acquisition style of growth. It has a focus on increasing its mix of recurring revenue while at the same time strengthening its ability to compound cash flow.
Another company with a high Magic Formula rating is Accenture PLC (NYSE:ACN), a multinational professional services company based in Ireland. It operates a network of businesses that provide corporate clients with consulting, technology, outsourcing and alliance solutions.
The company has an earnings yield of 4.48%, a return on capital of 170.73% and a business predictability rating of 5 out of 5 stars.
On Dec. 8, shares of Accenture traded around $246.13 for a market cap of $155.94 billion and a price-earnings ratio of 31.21, which is significantly higher than its 10-year median price-earnings of 19.06. The company has a financial strength rating of 8 out of 10 and a profitability rating of 9 out of 10. According to the GuruFocus Value chart, the stock is modestly overvalued.
In three of the four most recent quarters, the number of gurus buying the stock have outnumbered those selling it, with the second quarter of 2020 showing an equal number of buys and sells:
The volume chart tells a slightly different story, with buys outnumbering sells in two of the past four quarters. However, in the third quarter of 2020 and the fourth quarter of 2019, the buying volume was significantly higher than the selling volume, while the difference was much closer for the quarters where sells were higher than buys.
The most significant guru shareholder of the stock is Pioneer Investments (Trades, Portfolio) with 0.51% of shares outstanding, followed by Jeremy Grantham (Trades, Portfolio) with 0.27% and the MS Global Franchise Fund (Trades, Portfolio) with 0.09%.
Throughout its history, Accenture is a company that has relied on acquisitions and expansion in order to keep its profits increasing. This strategy has gained it a lot of moving parts to deal with. The company’s strategy for future growth revolves around gradually shifting away from slow growth areas and replacing them with services in fast-growing end markets like digital, cloud and security.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
Read more here:
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.