Cheap Magic Formula Stocks May 2024
One way I like to start the month is by seeing where the trends lie in one of my favorite "self-indexing" strategies, the Magic Formula. This screener was created by Joel Greenblatt in concert with his book, The Little Book That Beats The Market, which now stands as the most popular in the long-running "little book" series on investing.
The screening formula is simple, it hunts for the top 30-50 the cheapest stocks in the market, scored by their earnings yield and return on invested capital. A stock with an earnings yield of 10 and an ROIC of 10 would have a total score of 20. The higher the score, the cheaper the stock by this algorithm. This is my go-to strategy, along with buying the price-weighted Dow 30 one by one to get wide diversification while still scratching the itch of a single stock-buying enthusiast.
Large S&P 500 market cap sized stocks over $18 Billion
The screener I used in this month's example is a large cap, with a market capitalization of over $18 Billion. This is roughly the entrance fee required to gain admittance to the S&P 500. The screener can be set from $1 million to infinity, but I am most comfortable buying wide swaths of cheap, high-quality large cap stocks and just holding on to them for the long haul.
When market multiples get as high as they are right now, I like to be more diversified rather than concentrated in my overall "new money" allocations.
The list of high ROIC and high earnings yield stocks
Data Provided by: FactSet financial data and analytics and Seeking Alpha
STOCK TTM ROIC TTM EY SCORE (MO) 37.98% 13% 50 (ADM) 10.53% 9% 20 (BKR) 9.10% 8% 17 (BKNG) 33.69% 5% 39 (BLDR) 18.46% 8% 27 (CAH) 8.93% 9% 18 (COR) 34.86% 6% 41 (GIB) 15.20% 7% 22 (LNG) 36.30% 24% 61 (CSCO) 25.07% 9% 34 (CTSH) 15.17% 9% 24 (CMCSA) 8.34% 10% 18 (CVS) 5.77% 9% 15 (EBAY) 20.52% 9% 29 (EXPE) 9.41% 7% 17 (GIS) 12.78% 7% 20 (HAL) 15.20% 10% 26 (HPQ) 39.96% 12% 52 (KVUE) 8.51% 7% 15 (KDP) 5.84% 6% 11 (MPC) 18.48% 12% 31 (MCK) 85.39% 5% 90 (NUE) 17.08% 13% 30 (OMC) 14.58% 10% 24 (STLD) 21.48% 14% 35 (CI) 6.97% 7% 14 (ULTA) 34.49% 8% 43 (WSM) 30.65% 7% 37 (ZM) 8.89% 14% 23 (KHC) 4.14% 9% 13
The top 10 cheapest stocks on the list
While for the most part, I follow Joel Greenblatt's advice, buying the top 30 names by either equal or price weight, I also like to score each one individually myself to see what names are worthy of further capital allocation outside of this one fell swoop approach. The screener does not score the companies for you, but with the help of some simple math, Fact Set, and Seeking Alpha, I can quickly compile the scores for our perusal.
Do they pass the Peter Lynch EPS to share price chart test?
After accruing the scores of the top 10, I then pit them against Peter Lynch's charting test to make sure that the 10-year growth rate in earnings is trending above the 10-year growth rate in price. Lynch liked to use this indicator as his over-bought or over sold metric when examining growth stocks.
The bigger the gap between the 10-year price growth and earnings growth with price below earnings, the better. Furthermore, if a company can truly achieve a high ROIC organically without financial engineering and is cheap by earnings yield, then ipso facto the EPS growth should be trending ahead of the price growth.
Altria, Score 50 ✅
I must admit, Altria is not my cup of tea. It pays a large, nearly 9% yield in what I would think is a dying industry of "combustible" tobacco products. Nonetheless, the stock is a high-score staple of the Magic Formula screener and scores highly on the list with a score of 50. EPS growth is now trending above price growth on a 10-year basis.
Booking Holdings Score 39 X
This consumer discretionary travel and leisure booking company has been a solid performer over the past decade. The price trending ahead of EPS growth is more a function of outperformance leading to popularity than high ROIC investments not making it to the bottom line. Slightly over-bought, but a worthy stock if you don't mind over paying a bit.
Cencora Inc. Score 49 ✅
This healthcare equipment and pharmaceutical distributor both has a high MF score and a big GAAP earnings recovery post-2021. There is now a large gap between 10-year price and EPS growth. Attractive entry, although the EPS growth line is very cyclical and jagged.
Cheniere Energy, Inc. Score 61 ✅
The EPS to share price line tracked until 2022 when Cheniere's EPS growth line subsequently took off. The trailing twelve-month numbers are not expected to continue in the coming 12 months as earnings expectations are lower in conjunction with the depressed prices in natural gas. Still a nice gap between the two lines and an excellent magic formula score of 61.
Cisco Systems, Inc. Score 34 ✅
Cisco Systems is one of those "forever cheap" information technology companies that just can't seem to expand its multiple along with its peer group. Over the past decade, there has been about a 20% gap between EPS growth and price growth. This stock also sports a nice 3.4% dividend with growth for 12 years. Could this be the year Cisco comes back into favor post-2000 tech bubble? The stock is maintaining top and bottom-line growth with relatively flat price action. These are trends that I'm usually attracted to.
HP Inc. Score 52 X
A previous rather large purchase in the Berkshire Hathaway portfolio which has now been jettisoned, HP Inc. is a staple on the Magic Formula screener always appearing to maintain a high return on invested capital. However, when we chart out the earnings to share price growth, the share price is still well ahead of earnings growth and the share price has been rather flat. This is a case of financial engineering and the high ROIC numbers are not translating to earnings growth.
McKesson Corporation Score 90 ✅
Recent large bumps in earnings growth for this pharmaceutical-diversified health care company have skewed some numbers. While earnings growth is ahead of share price growth over the past decade, this comes after a dip into negative earnings territory during the Covid era.
Negative common equity skews this stock's numbers
The company also shows negative common equity on the balance sheet, with total assets less than total liabilities. This has skewed Fact Set's ROIC screener to reduce total invested capital with a negative common equity number. Because of this, I also crossed it off my list of most worthy large-cap magic formula stocks.
Steel Dynamics, Inc. Score 35 ✅
Nucor (NUE) was one of my best hits from taking apart and self-scoring a large cap magic formula list, with a total return of 66% since publishing that article. Steel Dynamics scored right under Nucor as one of the two top steel operations in the stock market. At this point, Steel Dynamics is taking the lead over Nucor from a magic formula valuation perspective:
Both have had very nice market beating returns over the past 3 years, and both remain highly scored magic formula companies.
Ulta Beauty, Inc. Score 43 ✅
I am personally not a huge fan of consumer discretionary retail, but the top and bottom line growth in Ulta Beauty has made it one of the hottest names in the market over the past few years. A slowdown in growth has created a nice pullback to where the 10-year earnings growth line now well exceeds the price growth. This may be one of the most likely stocks on the list to gap back to tracing the EPS growth line with a smaller market capitalization of just over $18 Billion, making growth easier due to the smaller scale of the company.
Williams-Sonoma, Inc. Score 37 X
Williams-Sonoma, everything home lifestyle company, has been on a parabolic run from 2023 until now. EPS growth is starting to tail off a bit, this could be due for a pullback. The two lines are close, and like Booking Holdings, the stock is still roughly fair value if the growth continues.
The pass/fail list of stocks whittled down
- Cheniere Energy 61
- Altria 50
- Cencora 49
- Ulta Beauty 43
- Steel Dynamics 35
- Cisco Systems 34
Risks
Cheniere tops the list but could have forward numbers that disappoint due to the cyclicality of the commodity they sell. Altria always scores high on this screener but could be in an eventual demise. The list of stocks starting with Cencora at #3 to Cisco at #6 seem to be on the most solid footing for continued growth from the eyeball test of their EPS trajectories.
Summary of the Magic Formula Portfolio
The Magic Formula is one of my favorite ways to diversify and "self-index". I would recommend the same thing Joel Greenblatt does, buy the entire list by your favorite weighting metric and then revisit after one year, the long-term capital gains marker. I like to hold them all rather than turn them over, but I have taken some nice gains from a few stocks that ran more than I expected them to via this investment method. This is my favorite way to scratch my stock-picking itch and still sleep well at night.
Brett Ashcroft Green
I'm a value investor who enjoys using classical value ratios to pick my portfolio. Long-term focused on low P/B, P/FCF, PEG ratios, the Graham Number and an occasional net-net hunter. I also believe in self-indexing primarily using the Dow Jones Industrial Average as my index of choice combined with Joel Greenblatt's Magic Formula. I'd like to consider my thought process to be an amalgamation of Ben Graham, Joel Greenblatt, and Peter Lynch. My working background is in private CRE financing. I'm also a fluent Mandarin speaker in both business and court settings. I have spent a good chunk of my adult working life in China and Asia.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of COR, CSCO, NUE, GIB, ADM, CAH, CMCSA, CVS, EBAY, GIS, HPQ, KVUE, KDP, MCK, OMC, CI, KHC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
The information provided in this article is for general informational purposes only and should not be considered as financial advice. The author is not a licensed financial advisor, Certified Public Accountant (CPA), or any other financial professional. The content presented in this article is based on the author's personal opinions, research, and experiences, and it may not be suitable for your specific financial situation or needs.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
