An interesting aspect of Joel Greenblatt's Magic Formula Investing (MFI) strategy is that its precepts can be applied to a variety of other stock strategies and focuses, as well. For example, if you like to invest in small caps, MFI can be used to find some good, undervalued businesses in a sector that is under-followed by professional equity analysts. If you are looking to invest in foreign markets, MFI can be applied to stocks in foreign exchanges, and so forth.
We can also go the other way, and apply additional criteria to stocks in the official MFI universe. In theory, doing this starts us with a list of good, undervalued companies, weeding out a lot of junk from the beginning. This article will focus on combing through the 3 screens covered by MagicDiligence (top 50 over 50 million and 1 billion, top 30 over 3 billion), looking for MFI stocks with relatively safe dividend yields above 3.5%, providing ongoing income for investors:
- Forward Dividend Yield: 5.7%
- Free Cash Flow Payout Ratio: 115%
- Consecutive Years of Dividend Hikes: 43
- Magic Formula Earnings Yield: 9.1%
- Magic Formula Return on Capital: 44.3%
Altria Group (MO) is the largest tobacco company in the U.S., producing the #1 brand of cigarette (Marlboro), and the #1 brand of smokeless tobacco (Copenhagen). Competitive dynamics are strong, as oppressive government regulation in the U.S. shuts out new competitors and hurts discount labels more than premium brands, and the firm produces copious amounts of free cash flow. Altria is a "dividend aristocrat", raising the dividend for 43 consecutive years. Recently, though, dividend payments have begun to outstrip free cash flow, so this is something to watch. Competitors Reynolds American (RAI) and Lorillard (LO) are also Magic Formula stocks and also interesting dividend investments.
- Forward Dividend Yield: 5.3%
- Free Cash Flow Payout Ratio: 36%
- Consecutive Years of Dividend Hikes: 42 before being broken in 2010
- Magic Formula Earnings Yield: 16.0%
- Magic Formula Return on Capital: 54.1%
One of the largest pharmaceutical makers in the world, with products like Cymbalta for depression and antipsychotic Zyprexa. Payout ratio is modest and Lilly has a stellar dividend record. Some concerns are a high debt load after purchasing ImClone in 2008 and a large patent cliff in the next 2 years (over 40% of sales). A decent pipeline of new drugs and cost cutting will be key in maintaining and raising the dividend, and the payout ratio is safe for now. At a 16% earnings yield, there is also significant capital appreciation potential if the R&D pipeline can deliver. Like tobacco, branded pharmaceuticals have an outstanding long-term investment record.
- Forward Dividend Yield: 3.8%
- Free Cash Flow Payout Ratio: 32%
- Consecutive Years of Dividend Hikes: 8
- Magic Formula Earnings Yield: 12.0%
- Magic Formula Return on Capital: 30.7%
Lockheed is the largest of the "big 5" defense contractors. The firm is well-known for producing fighter jets, stealth bombers, and transport planes, and has sizable divisions devoted to space-based systems, missiles, and military information technology. Lockheed has recently reported a solid backlog, but continuing delays and cost overruns in the important F-35 program are a concern. This is a wide moat, economically insensitive firm with a low payout ratio and solid dividend yield, making it an interesting choice for the income-oriented investor. Competitors Northrop Grumman (NOC) and Raytheon (RTN) are also good dividend-paying Magic Formula stocks at present.
- Forward Dividend Yield: 6.1%
- Free Cash Flow Payout Ratio: 33%
- Consecutive Years of Dividend Hikes: 0 (last cut in 2008)
- Magic Formula Earnings Yield: 13.8%
- Magic Formula Return on Capital: 149.6%
United Online is a mini-conglomerate consisting of one declining business in NetZero/Juno, one flat business in Classmates.com, and one with decent potential in FTD. Classmates.com has held up pretty well but faces the onslaught of Facebook as a free alternative. FTD should provide good stability for a long time, although it does face heavy pricing competition. I like UNTD for its high current yield, very low payout of cash flow, and stock price potential considering the low earnings yield. On the down side, the company has 2.5 times more debt than cash on the balance sheet and relies on two declining businesses for 65% of operating profits.
5) MIND C.T.I. (MNDO)
- Forward Dividend Yield: 9.2%
- Free Cash Flow Payout Ratio: 60%
- Consecutive Years of Dividend Hikes: N/A (paid on a portion of earnings)
- Magic Formula Earnings Yield: 12.4%
- Magic Formula Return on Capital: 226.4%
This tiny Israeli company provides billing and customer management software for wireline, wireless, and VoIP communications providers. Recently the firm has announced contracts with larger telecom providers, such as Canada's EastLink and Israel's Partner Communications (PTNR). The dividend policy is pretty unique - MIND pays out all of the previous year's net income in the form of a dividend! This has led to some outstanding yields over the past 5 years, averaging well over 10%. As the company continues to sign larger contracts, the potential for fantastic dividend yields should only increase going forward. And the stock is cheap as well, leaving open the door for capital gains, too.
Disclosure: Steve owns MNDO