When fund manager Joel Greenblatt published his investing tome, The Little Book That Beats the Market, in 2005, it marked a unique point for investors. They now had insights into easily replicated investing strategies developed by a value investing master. Greenblatt has achieved phenomenal results over the past two decades, besting even the performance of Warren Buffett.
His strategy is deceptively simple: Buy undervalued, high-performing companies and hold for a year. Wash, rinse, and repeat. But what if we could augment Greenblatt's methodology?
Below, we've used a "magic formula"-like screen that approximates the pre-tax earnings and return on capital criteria he lays out, but adds the ratings from our Motley Fool CAPS investor-intelligence database. Combining those rankings with the criteria that Greenblatt suggests should give us winning investments that may just produce some outsized returns.
Here are a few companies that showed up when I ran this screen recently.
| Stock | Pre-Tax Earnings Yield % | Pre-Tax Return on Capital % | Recent Stock Price | CAPS Rating |
|---|---|---|---|---|
| American Physicians Capital (Nasdaq: ACAP) | 25% | >100% | $31.73 | ** |
| Claymore Dividend & Income Fund (NYSE: DCS) | 20% | >100% | $12.18 | ** |
| HealthTronics (Nasdaq: HTRN) | 33% | >100% | $2.55 | ***** |
| USA Mobility (Nasdaq: USMO) | 34% | >100% | $12.81 | ** |
| Vaalco Energy (NYSE: EGY) | 36% | >100% | $4.83 | **** |
Source: Yahoo! Finance CapitalIQ, a division of Standard & Poor's; Motley Fool CAPS. Pre-tax earnings yield is inverse of EV/EBIT. Pre-tax ROC is EBIT divided by tangible capital employed.
Although Greenblatt's strategy is a mechanical one, we don't think you should just rely upon this as a simple list of companies to buy. Due diligence on this narrowly focused list of companies is always a smart requirement. Let's see what CAPS members have to say about these magical companies.
A little bit of pixie dust
West African oil producer Vaalco Energy reported a loss of $1.7 million or $0.03 per diluted share in the second quarter, compared with a $13 million, $0.22-per-diluted-share profit a year ago. The major contributing factor: fallen oil prices.
Given the rocky road crude oil has taken this year, it's not surprising to see these kinds of results. After all, oil behemoth ExxonMobil (NYSE: XOM) recorded record profits last year, only to post its worst earnings results in years just last month. ConocoPhillips (NYSE: COP) hit a gusher when oil was soaring last year, but saw earnings plummet 76% this quarter, even though it produced more oil this quarter than in the same period last year.
For its part, Vaalco pumped 24,000 barrels of oil per day in the quarter, a record for the oil producer. Now, that's nothing when stacked against ConocoPhillips' 1.87 billion per day, but Vaalco is still moving in the right direction. It has eight producing wells offshore of Gabon, and it's producing more oil all the time. It sold 80,000 more barrels of oil this quarter than a year ago, but with oil at an average of $59 a barrel, compared with $119 last year, the hit its earnings took was not unexpected.
CAPS member cheatcountry likes Vaalco Energy's market value and low debt levels. It has more than $88 million in cash and just $5 million in long term debt, placing it in a strong financial position to grow out its operations. Highly rated CAPS All-Star member becon800 figures history is on Vaalco's side:
[Vaalco Energy] never stays below $4 for long, and when it does dip below, it bounces back quickly. Oil has gone up in the last quarter, so look for increased revs and earnings. Sell at $4.50 to $4.60.
The volatility of oil prices will continue to make it difficult to evaluate year-over-year financials accurately. While oil currently trades at about $70 a barrel, a future increase in price will surely make it easier to construct apples-to-apples comparisons, providing firmer ground from which to assess companies like Vaalco Energy.
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