In his 2005 bestseller “The Little Book That Beats the Market,” Joel Greenblatt (Trades, Portfolio) introduced the investing world to the Magic Formula, a simple mathematical formula to find profitable businesses that trade at bargain prices.
The formula ranks companies primarily based on two metrics: earnings yield and return on capital. Greenblatt defines the earnings yield as earnings before interest and taxes (Ebit) divided by enterprise value; this metric measures how much the company earns compared to how much the stock is valued by the market. The return on capital, meanwhile, is calculated as Ebit divided by the sum of net fixed assets and net working capital and measures how much a company earns compared to what it spends to produce those earnings.
One way that investors can search for stocks based on Greenblatt’s Magic Formula is through the GuruFocus Magic Formula Screener. Not only can this screener look for Magic Formula stocks, it can also organize the stocks based on criteria such as business predictability, dividend yield, price-earnings ratio and Ebitda growth.
According to the Magic Formula screener, three stocks that rank highly based on Magic Formula criteria and also offer market-beating dividend yields at cheaper than normal prices are Paramount Global (PARA, Financial), 3M Co. (MMM, Financial) and Whirlpool Corp. (WHR, Financial).
Paramount Global
Paramount Global (PARA, Financial) is a media and entertainment company with an earnings yield of 17.24% and a return on capital of 120.66%, putting it ahead of 84% of industry peers for both metrics. The stock also sports a dividend yield of 4.62% and a price-earnings ratio of 4.37, which is below its historical median price-earnings ratio of 15.42. The forward price-earnings ratio is 14.26, though, as analysts expect advertising revenue to continue falling amidst a recession.
I’ve been following Paramount Global since Viacom and CBS re-merged near the end of 2019. The merged company rebranded as Paramount Global in February 2022 in a bid to gain ground in the rapidly transforming and highly competitive media and entertainment landscape. This puts the famous Paramount Pictures studio and streaming service Paramount+ front and center for investors to focus on.
Competition may be tough, but Paramount+ is rapidly adding subscribers. As of its most recent earnings for the third quarter of 2022, the company had 46 million subscribers and, more importantly, it was the number one U.S. streaming service in terms of year-to-date gross subscriber additions. Top assets include the rights to stream NFL games, UEFA Champions League games and Paramount Pictures’ movies. It’s possible that the market is undervaluing Paramount Global’s potential due to the intense competition in the streaming industry as well as the way Netflix’s (NFLX, Financial) valuation tanked when it reported a subscriber loss in April 2022.
3M
Industrial and consumer goods conglomerate 3M (MMM, Financial) has an earnings yield of 9.27%, beating 58% of industry peers, and a return on capital of 56.46%, which is higher than 84% of other conglomerates. The dividend yield of 4.72% is solid, and the company is also cheaper than usual based on its current price-earnings ratio of 11.03 compared to its historical median price-earnings ratio of 19.96. Its forward price-earnings ratio is 12.05.
Minnesota-based 3M, or Minnesota Mining and Manufacturing Company, is a diversified conglomerate that operates mainly in the fields of industry, worker safety, U.S. health care, consumer goods, electronics components and adhesives. If you live in the U.S., chances are you have seen 3M products in many places before, from the supermarket and home improvement stores to the doctor’s office and even your own home with air filters, water purifiers, electrical components, etc. The company also sells its products globally.
Given the size of the company as well as its slow growth and defensive industry characteristics, 3M will not ever be a growth stock investment, and it is also subject to short-term pressures when the economy sours into a recession. However, demand for its products should remain relatively strong even in a recession, and we can count on an eventual rebound, which may attract investors to the high dividend yield in times of uncertainty.
Whirlpool
Home appliance company Whirlpool (WHR, Financial) has an earnings yield of 7.62%, topping 58% of industry peers, and a return on capital of 25.88%, which beats 68% of competitors. The dividend yield is more than double the historical median at 4.55%. Whirlpool’s price-earnings ratio of 24.87 is above its historical median of 16.07, but its forward price-earnings ratio drops to 10.22 as analysts expect earnings to recover from a huge drop in 2022 that occurred as the company wrote down $747 million worth of assets due to exiting its Russia business and preparing to divest its Europe, Middle East and Africa operations.
Whirlpool’s downsizing efforts are only part of what is putting pressure on its stock price. The exit from Russia makes sense in light of geopolitical tensions, and divesting its EMEA business may turn out to be more beneficial than keeping it, as the company has formed a new entity with Turkey’s Arcelik to better serve the regional market (Whirlpool will own 25% of the new entity and retain ownership of EMEA KitchenAid). What’s more worrying is that the company has been implementing layoffs and production slowdowns recently due to the worsening macroeconomic situation.
Through the highs and lows of the economy, Whirlpool has paid dividends uninterrupted since 1955, maintaining payouts in downturns and raising payouts when times are good. The company has a long-term goal of investing 6% of sales into growth, so the strong dividend is the main focus for investors. Whirlpool rarely offers a yield this high, though it should be noted the company has a history of losing a huge chunk of its stock price in recessions, so an even higher yield might appear if the global economy continues its decline.
