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The Barron's 500 Ranked as Magic Formula Stocks

May 10, 2011 12:42 PM ETAPOL, OSK, BB, LHX, RAI, LLY, CA, ROST, ALV, GILD
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Last week two major investing publications - Forbes and Barron's - released their 2011 Top 500 lists of publicly traded companies. The biggest difference between the two lists are their ranking and inclusion criteria. While Forbes simply takes the top 500 companies by revenues, Barron's does a bit more work and ranks the stocks based on three criteria: revenue growth in 2010, 3-year average cash returns on investment, and 2010 cash returns on investment vs. the median firm. This makes Barron's list a bit more interesting and much more dynamic. Firms at the top of the list are expected to be fast growing companies that efficiently invest their capital, creating the greatest economic returns for shareholders (whether or not the stock price reflects it, yet).

A couple of weeks ago, MagicDiligence wrote about how the Magic Formula Investing (MFI) strategy could theoretically be applied to any group of stocks. This is a perfect opportunity to put that into motion. I've taken the top 100 non-financial stocks from Barron's list and ranked them by the MFI method. The result should be a list of efficient, revenue growing stocks that are also have cheap stock prices! The full ranking list can be found here.

For the rest of this article, let's take a look at the top 10 in that list:

Ticker Company Price Quarter EY MFI-ROIC CR MFI
APOL Apollo Group, Inc. $40.62 2011-02-28 26.3% 151.7% 1.44 1 81
OSK Oshkosh Corporation $30.42 2011-03-31 25.0% 107.1% 1.44 2 1
RIMM Research In Motion Limited $44.85 2011-02-28 21.1% 96.2% 2.06 3 8
HRS Harris Corporation $49.14 2011-03-31 13.4% 60.3% 2.01 4 107
RAI Reynolds American, Inc. $37.50 2011-03-31 9.8% 124.6% 1.10 5 47
LLY Eli Lilly and Company $38.65 2011-03-31 15.9% 48.2% 2.01 6 103
CA CA Inc. $24.33 2010-12-31 9.4% 116.8% 1.18 7 44
ROST Ross Stores, Inc. $78.98 2011-01-31 10.2% 84.7% 1.51 8 63
ALV Autoliv Inc. $77.69 2010-12-31 12.1% 55.1% 1.47 9 89
GILD Gilead Sciences, Inc. $41.36 2010-12-31 10.5% 63.4% 2.32 10 75

Magic Formula investors probably are not too surprised... 5 of those stocks are currently in the MFI screens, and most of the others have been in it within the past 6 months. Only 2 stocks - Oshkosh and Research in Motion - made the top 10 both by Barron's criteria and by MFI's. Additionally, one current MFI stock, Visa (V), was #10 on Barron's list but did not rank per my calculations.

Certainly there are reasons to be wary of some of them. Oshkosh is coming off of a huge government contract for mine resistant ATVs, and revenue is sure to drop going forward. Research In Motion, while still a growing company, has had to cut estimates this year and faces intense competition from Apple's (AAPL) iPhone/iPad and numerous devices running Google's (GOOG) Android operating system. Eli Lilly is facing a patent cliff from 2011-13 that threatens 40% of revenues. Reynolds pays a nice dividend and operates in an oligarchy with strong pricing power, but has few avenues for growth. So, clearly, there are reasons for some of these stocks to be cheap, but almost every stock becomes too cheap at some point. It can be argued that several of the aforementioned names may meet that description.

The second "basket" we can put these stocks into are ones that face likely short-term problems, making them potentially interesting to value investors. For example, Apollo Group has been suffering huge enrollment declines as they transform their business ahead of government regulations, but once this transition laps over, I believe investors will find current valuation levels far too low for the amount of ongoing business.

Lastly are the firms that just look plain undervalued, with no hugely concerning business challenges looming overhead. Gilead dominates the HIV drug space, has years of patent protections ahead, and is still growing at a slower but still healthy pace. CA is still viewed as a mainframe software company, but the truth is that the firm is investing heavily into growing sectors like software-as-a-service, security, and machine virtualization.

Disclosure: Steve owns GILD, APOL

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