The current issue of the 10x45 Bargain Hunter (pdf file) stock screening report, published on August 23rd, includes a table of the Top 45 "Magic Formula" Stocks, based on current consensus estimates of this year's earnings per share. This "Magic Formula" screen is based on a methodology advocated by Superinvestor Joel Greenblatt, author of The Little Book That Beats The Market.
Here are 10 'magic formula' companies that deserve a closer look:
- GigaMedia (GIGM) is engaged in the growing business of providing gaming software and services to the online gaming industry in China, Taiwan, Hong Kong, and Macau. The company's solid balance sheet and valuation of 0.6x enterprise value to trailing revenue make GigaMedia worthy of consideration. We note, however, that the company has not reported quarterly results since Q1, which is a significant concern for investors.
- EarthLink (ELNK) is a “cash cow” business offering commoditized Internet access to consumers and businesses. Management has made a strategic decision to cut backend costs and marketing expenses in order to maximize FCF generated by existing customers. At a 13% earnings yield based on this FY EPS estimates, the shares deserve a look, but investors should make conservative assumptions about future ARPU and churn.
- Pre-Paid Legal (PPD) is a company with a theoretically appealing value proposition. Unfortunately, the company has not yet found the right formula to grow membership beyond the current 1.5% of addressable households. PPD’s multi-level marketing strategy may present a hurdle to widespread adoption of the pre-paid legal service. We recognize that it would be exceedingly difficult to revamp the sales strategy due to the risk of transitional channel conflict. As a result, PPD may be stuck in a strategy that could keep it a marginal provider of legal services for a long time.
- PRG-Schultz (PRGX) provides recovery audit services to companies and government agencies with large transaction volumes. The company’s fundamental problem is a declining core business with a concentrated client base whose need for the company’s services diminishes over time due to improved payment processes and greater in-house capabilities. However, the company occupies a defensible niche in business services and offers high ROI to customers. While the retail and wholesale customer base has suffered disproportionately in the recession, PRG-Schultz shares appear materially undervalued, trading at an earnings yield of 11% based on estimated 2009 earnings. JANA Partners owns 10% of the company.
- Foster Wheeler (FWLT) is an engineering and construction contractor and power equipment supplier that has executed well in recent years, benefiting from global growth and strength in energy-related industries. The company has a rock-solid balance sheet and bought back more than $400 million of stock in 4Q08. The shares price in a sharp near-term downturn in business, making this a potentially interesting opportunity for contrarian investors. Investors should monitor the so-called “scope” backlog to gauge Foster Wheeler’s resilience in a weak operating environment.
- Apollo Group (APOL), founded in 1973, provides on-campus and online degree programs for undergraduate and graduate students. Apollo’s University of Phoenix is the largest private education provider, with 400,000+ students concurrently enrolled in 100+ degree programs (online or on campus). The company has weathered the recession quite well due to the countercyclical nature of postsecondary education, continued industry growth and market share gains. Apollo has an attractive business model, with operating margins in the mid 20s, low capital intensity, and strong FCF generation. With three-fourths of revenue related to Title IV, the biggest long-term risk appears to be government action that would compress profit margins.
- GT Solar (SOLR) provides manufacturing equipment and services for the production of photovoltaic, wafers, cells and modules, and polysilicon worldwide. While we normally avoid solar companies because the entire sector has been hyped for quite some time, GT Solar is interesting both from a valuation standpoint as well as the fact that respected value investment firm Oaktree Capital Management owns more than 5% of the shares.
- Synopsys (SNPS) provides electronic design automation software and related services to semiconductor companies worldwide. The EDA segment remains one of the most attractive places in the semiconductor value chain, and Synopsys is a leader in the space. The company derives a large portion of revenue from recurring software subscription fees, improving the steadiness and predictability of the business. High-quality tech companies such as Synopsys rarely trade cheaply enough to appear on a 'magic formula' screen, which is why we take note of it here.
- Aeropostale (ARO) is a mall-based specialty retailer of casual apparel and accessories, targeting 14 to 17 year-old young women and men through its Aeropostale stores and 7 to 12 year-old kids through its P.S. from Aeropostale stores. The company enjoys strong brand recognition in its traget demographics, competing primarily against American Eagle (AEO) and Abercrombie & Fitch (ANF). Trading at 10x this year's estimated earnings, ARO shares deserve closer attention.
- Hewlett-Packard (HPQ) needs no introduction. The recent trading price implies a current earnings yield of roughly 9%, quite respectable for this industry leader. Respected value-oriented fund managers Steve Mandel of Lone Pine and Dan Loeb of Third Point initiated positions in Hewlett-Packard during the second quarter.
Top 45 "Magic Formula" Stocks (based on this FY EPS estimates)
click to download pdf version
Source: The Manual of Ideas, BeyondProxy LLC.
Disclosure: No positions