Many serious investors are becoming familiar with Joel Greenblatt's "Magic Formula," where he takes the earnings yield and return on capital for a group of stocks, ranks them from best (ranked #1) to worst and then adds the two numbers together. The lower a company's combined score, the better. When it comes to screening stocks, this kind of exercise is great because it combines more than one attribute, allowing for a little wiggle room.

IN PICTURES: Learn To Invest In 10 Steps

For example, just because a stock's price-to-sales ratio is above the industry average, doesn't mean it isn't a good buy. To illustrate this point, here are the largest processed and packaged goods companies analyzed using forward price-to-earnings, price-to-book, price-to-sales and price-to-cash flow as screening criteria. While it isn't perfect, the "Magic Formula" serves a useful purpose.

Top 10 U.S. Processed and Packaged Goods Companies

Combined My Formula Score Magic Formula Score Combined Score
Campbell Soup (NYSE:CPB) 21 2 23
Ralcorp (NYSE:RAH) 11 13 24
Con Agra (NYSE:CAG) 9 16 25
Sara Lee (NYSE:SLE) 13 15 28
McCormick & Company (NYSE:MKC) 24 5 29
Kellogg (NYSE:K) 26 6 32
JM Smucker (NYSE:SJM) 18 15 33
General Mills (NYSE:GIS) 26 9 35
Pepsico (NYSE:PEP) 29 9 38
Green Mountain Coffee Roasters (Nasdaq:GMCR) 38 19 57

We Have A Winner
Campbell Soup came out on top when combining my formula, which tends to favor value-oriented stocks, with Greenblatt's "Magic Formula," which favors those with strong earnings. While one of Greenblatt's two criteria is return on invested capital, I tend to favor the cash return on invested capital (CROIC) instead because it gives a better idea of a company's cash generation from operations. The higher the return the better.

In Campbell Soup's case, it came out on top at 18.5% with Pepsico second at 17.1% and McCormick & Company third at 13%. With CROIC replacing ROIC, Campbell Soup had the lowest Magic Formula ranking followed by McCormick & Company and Kellogg.

Green Mountain Too Hot
Coming in last is Green Mountain Coffee Roasters, the second best stock performer of the past decade. I like the company and its management but its stock is expensive. The winner using my formula is Con Agra, the maker of Orville Redenbacher's, Chef Boyardee and Healthy Choice brands. Morningstar gives it just two stars because of its lack of innovation and I would tend to agree. It's one reason why its stock is cheap - it's hard to get excited about its products. None of them stands out in a crowd. As for Campbell Soup, it finished middle of the pack using my formula, which is just fine.

Making Sense Of It All
Investment analysis is a lot like analyzing baseball statistics in that you can take all sorts of numbers and contort them into seemingly meaningless variables all in hopes of better understanding the company or player you're interested in.

You likely wouldn't compare the home run production of designated hitters with those of second basemen, but you would compare the home run stats of all 30 second basemen in Major League Baseball looking for that special combination of power, speed and fielding. Investing is no different. Using formulas like Greenblatt's, you see businesses from different sides, making it easier to spot the winners.

The Bottom Line
Campbell Soup cut its 2010 sales guidance February 17 as it continues to struggle with its soup business. It's not a huge concern as profitability won't change much, but management continues to look for ways to grow its legacy brand beyond current levels. As long as earnings remain strong, this tinkering is a sign they're not being complacent.

Have you ever wondered why its return on equity is 71.6%? The company repurchases its shares in huge quantities, reducing overall shareholder equity. In the past three years, Campbell has bought back $2.57 billion of its stock at an average price of $35.21 a share. While it has paid more for the shares than the equivalent amount it is worth today, that likely won't be the case for much longer. (Make an informed decision about your investments with these easy equations. For more information, see Analyze Investments Quickly With Ratios.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  9. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  10. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!