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Joel Greenblatt is the founder of Gotham Capital, a hedge fund with extremely good returns. We like Greenblatt because he’s smart and not so secretive about his investment style. He’s authored two books, You Can Be A Stock Market Genius and The Little Book That Beats the Market.

In the The Little Book, Greenblatt describes a quantitative strategy – which he calls the "magic formula" -- to pick stocks. It’s actually a very simple quantitative stock ranking scheme. It uses return on capital and earnings yield as inputs. Return on capital is the metric that shows whether a business is a good one or not. Earnings yield is the metric that shows whether a company is cheap or not. Greenblatt suggests using these measures to identify good but cheap businesses, and buy them.

That’s the secret behind the "magic formula." In The Little Book, Greenblatt calculated hypothetical returns for the 1988-2004 period. The magic formula returned an average 30.8% per year, while the market return was 12.3% and the S&P 500 returned an average 12.4%.

Recently Greenblatt started implementing his “enhanced” magic formula, which was updated after rigorous quantitative research. Luckily for ordinary investors we have a delayed access to Greenblatt’s 13F portfolio which have stocks that are picked by the enhanced magic formula. Here are the top 50 stocks in Greenblatt’s 13F portfolio:

Company

Ticker

Return

Value (x1000)

INTERDIGITAL INC

IDCC

4.2%

7,453

SANDISK CORP

SNDK

-11.5%

7,253

MCGRAW HILL COS INC

MHP

7.5%

6,462

OSHKOSH CORP

OSK

-0.7%

6,208

LORILLARD INC

LO

10.5%

6,031

MEDICIS PHARMACEUTICAL CORP

MRX

12.2%

5,786

MICROSOFT CORP

MSFT

-8.7%

5,479

IMPAX LABORATORIES INC

IPXL

19.3%

5,204

FOREST LABS INC

FRX

-2.7%

5,197

CAREER EDUCATION CORP

CECO

4.1%

5,187

LENDER PROCESSING SERVICES INC

LPS

10.8%

4,826

TERADYNE INC

TER

25.2%

4,688

VIROPHARMA

VPHM

12.1%

4,669

AEROPOSTALE INC

ARO

-2.6%

4,605

CUBIST PHARMACEUTICALS INC

CBST

16.4%

4,420

EMCOR GROUP INC

EME

10.6%

4,419

RAYTHEON CO

RTN

9.7%

4,397

APOLLO GROUP INC

APOL

4.2%

4,210

G T SOLAR INTERNATIONAL

SOLR

16.8%

4,170

MEDNAX INC

MD

-4.9%

4,140

REYNOLDS AMERICAN INC

RAI

5.6%

3,979

NEUSTAR INC

NSR

-1.8%

3,910

VEECO INSTRUMENTS INC DEL

VECO

18.3%

3,758

BLOCK H & R INC

HRB

37.7%

3,520

DELL INC

DELL

8.6%

3,223

GARMIN LTD

GRMN

9.1%

3,187

ACCENTURE LTD IRELAND

ACN

3.8%

2,971

GAMESTOP CORP NEW

GME

-7.4%

2,795

GILEAD SCIENCES INC

GILD

11.1%

2,766

A O L INC

AOL

-20.3%

2,726

ENDO PHARMACEUTICALS

ENDP

-2.2%

2,306

SOHU COM INC

SOHU

25.7%

2,299

ASTRAZENECA PLC

AZN

5.1%

2,289

BUCKLE INC

BKE

-2.3%

2,240

UNISYS CORP

UIS

24.1%

2,168

NOKIA CORP

NOK

-18.6%

2,101

DECKERS OUTDOOR CORP

DECK

1.7%

2,097

WEIGHT WATCHERS INTL INC

WTW

65.4%

2,092

SEAGATE TECHNOLOGY

STX

-10.2%

2,011

AMEDISYS INC

AMED

4.9%

1,998

GROUPE C G I INC

GIB

17.2%

1,996

GLAXOSMITHKLINE PLC

GSK

-2.0%

1,993

CEPHALON INC

CEPH

-7.9%

1,944

DEVRY INC DEL

DV

9.5%

1,932

ALTRIA GROUP INC

MO

3.7%

1,909

HARRIS CORP

HRS

6.5%

1,868

LAM RESH CORP

LRCX

0.6%

1,848

S A I C INC

SAI

6.2%

1,844

ARRIS GROUP INC

ARRS

8.9%

1,820

AMERISOURCEBERGEN CORP

ABC

11.2%

1,765

These 50 stocks returned 6.6% since the end of 2010, vs. SPY’s 3.6% return. Clearly, magic formula on steroids beats the market by an average of 1 percentage point per month. The best performing stock was WTW, returning more than 65% in less than three months. HRB returned more than 37%, beating the market by 34 percentage points. Ray Dalio’s Bridgewater and Andreas Halvorsen’s Viking Global were among the other hedge funds with HRB holdings. SOHU returned 26%, beating the SPY by 23 percentage points. John Griffin’s Blue Ridge had also SOHU in its portfolio at the end of December.

Teradyne was another stock with excellent performance, returning more than 25%. David Tepper’s Appaloosa had Teradyne in its portfolio as well. As one can see, hedge funds that utilize fundamental analysis also buy these stocks because they are mostly high quality bargain stocks. We will keep following Greenblatt’s new stock picks and performance.

Source: Gotham Capital's Stock Picks