'Magic Formula' Value Investor Joel Greenblatt's Low P/E Picks

by: Insider Monkey

By Matt Doiron

Joel Greenblatt is known in the value investing community for his books on the subject (including You Can Be a Stock Market Genius), for his Value Investors Club, and for his "Magic Formula" investment strategy. Greenblatt also files 13Fs with the SEC six to seven weeks after the end of each quarter, and since his positions often don't change by much we can assume he owns many of the stocks he still owned at the end of December (see Greenblatt's stock picks). We track 13F filings from hedge funds and other notable investors for a variety of reasons, including to help us develop investing strategies (the most popular small cap stocks among hedge funds, for example, generate an average excess return of 18 percentage points per year). In Greenblatt's case we thought it might be helpful to look at traditional value stocks, so here are his top five picks with both trailing and forward P/Es of 10 or lower:

Greenblatt reported a position of about 300,000 shares on Raytheon Company (NYSE:RTN). The aerospace and defense company trades at only 10 times earnings (on both a trailing and a forward basis) as markets expect it to be hit by cuts in U.S. military spending, a key source of revenue. Even as is Raytheon's business has been struggling, with earnings falling 14% last quarter compared to the fourth quarter of 2011. The stock does pay a decent dividend yield of 3.6%, and might be an interesting prospect for income or defensive investors. As a value stock we'd be interested in comparing Raytheon to its peers.

During the fourth quarter of 2012, Apple Inc. (NASDAQ:AAPL) lost its place as the most popular stock among hedge funds, to be replaced by AIG (find more stocks hedge funds loved). Greenblatt, meanwhile, more than doubled his holdings of Apple to over 25,000 shares. The stock price is down 22% in the last year as the market expects gross margins to fall and pull earnings down with it (the trailing P/E is only 10, so the stock would be a good value even if net income was flat). We certainly don't expect Apple to continue being a high growth company but we think it may have fallen to the point where it is trading at value levels.

PDL BioPharma Inc. (NASDAQ:PDLI) was another of Greenblatt's stock picks. PDL BioPharma is an intellectual property manager which owns drug patents; its market capitalization is a little less than $1 billion (on average, over 2 million shares are traded per day so there is plenty of volume). PDL BioPharma is loved by analysts, which results in a low forward P/E multiple, but 14% of the outstanding shares are held short so we would be on the lookout. Going by recent dividend payments it might be an income prospect.

The 13F disclosed ownership of about 220,000 shares of CACI International Inc (NYSE:CACI), a $1.2 billion market cap IT solutions and services company. A number of its products cater to federal government needs, including national security customers specifically, and so we'd be concerned about the effect of spending cuts here as well. While the stock is cheap, and the sell-side is projecting enough growth that the five-year PEG ratio is only 0.6, both revenue and earnings declined in the fourth quarter of 2012 versus a year earlier. CACI is also a popular short target with 16% of the outstanding shares held short.

Greenblatt upped his stake in HollyFrontier Corp (NYSE:HFC) between October and December and closed 2012 with close to 240,000 shares in his portfolio. HollyFrontier is an oil and gas refining and marketing company (producing fuels, asphalt, and other products) with a market capitalization of $11 billion. There seems to have been an abnormal increase in net income last year, but even so analyst expectations have the stock trading at 10 times forward earnings estimates. We would be interested in learning more here as well.

Disclosure: I am long AAPL.

Business relationship disclosure: This article is written by Insider Monkey's writer, Matt Doiron, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.