Top 5 'Magic Formula' Stocks to Add to Your Watchlist

What if I told you there was a magic formula you could use to beat the market? One that was extremely simple and could potentially ensure high returns, consistently, for many years.

You wouldn't believe me, right?

If there was a formula, you wouldn't need an investment advisor or guide. You could just build a portfolio that would beat the market on its own.

But there is such a formula. And it works.

The 'Magic Formula' was created by hedge fund manager and Columbia University professor Joel Greenblatt. It involves buying undervalued stocks based on two parameters - high earnings yield and return on capital (RoC).

The earnings yield tells us whether the company is available at an attractive price. The RoC tells us how well the company has used its capital.

The 'Magic Formula' gives both ratios equal weightage while selecting companies. Then it ranks those companies by both ratios.

The formula finally gives the best combined rankings of these companies. An investor can buy and hold these stocks for at least a year.

With the help of this formula, several fund management companies have generated significant return. Greenblatt himself claimed that he was able to generate a 30% return using the formula.

Here are five Indian stocks that rank well on the magic formula's parameters.

#1 P&G Hygiene & Healthcare

The first stock on our list is P&G Hygiene & Healthcare.

The company is the Indian subsidiary of the American MNC, Procter & Gamble. It's engaged in the manufacturing and selling of branded packaged consumer goods in the feminine hygiene and healthcare business.

Its portfolio includes popular brands such as Whisper, Vicks, and Old Spice.

P&G Hygiene and Healthcare ranks the highest on both criteria of the magic formula. Its RoC is 128% and its earnings yield is 1.3%.

The company's revenue has grown at a CAGR of 13.3% in the last 3 years. Its net profit has grown at 20.3%. It has no debt on its books and has a dividend yield of 2.1%.

In the latest quarterly results, P&G Hygiene reported a marginal increase in revenue. However, the company reported a 15.4% YoY decline in net profit as commodity inflation and ad spends impacted profitability.

For more details about P&G, check out its factsheet.

#2 L&T Infotech

The next stock on our list is L&T Infotech.

L&T Infotech is an Indian information technology services and consulting company based in Mumbai, India.

The company provides a wide range of IT services such as application development maintenance (ADM), enterprise solutions, infrastructure management services, testing, analytics, and artificial intelligence.

It has over 450 clients, of which 70 are global fortune 500 companies.

L&T Infotech has a RoC of 36.8% and an earnings yield of 1.7%.

The company's revenue has grown at a CAGR of 19.2% in the last three years. Its net profit has grown at a CAGR of 20.3%. It also has no debt on the books.

For the December 2021 quarter, L&T Infotech reported a 31% YoY increase in revenue and 18% YoY increase in net profit. This was on the back of robust and broad-based growth.

Indian IT services companies reported a pick-up in business during the pandemic, as businesses shifted to higher use of digital technologies.

L&T Infotech has hired over 1,200 people on a net basis during the quarter. Its employee strength is 44,200. The company said it will continue hiring as the business grows.

For more details about the company, check out its factsheet.

#3 Mindtree

The third stock on the list is Mindtree.

Like L&T Infotech, Mindtree is a multinational information technology services and consulting company. It's a part of the L&T group.

The company deals in e-commerce, cloud computing, digital transformation, data analytics, and enterprise resource planning.

Mindtree has a RoC of 35.9% and an earnings yield of 1.6%.

Its revenue has grown at a CAGR of 13.4% in the last three years while net profit has grown at a CAGR of 24.9%. Mindtree has no debt on its books.

In the latest quarterly results, the company reported a 36% YoY increase in revenue. Net profit grew 34% YoY.

Mindtree recently unveiled a three-pronged strategy to sustain revenue growth momentum. The Bengaluru-based IT firm said it plans to accelerate its core portfolio, expand its emerging portfolio, and incubate its new portfolio.

The company said it will strive to take clients, talent, and stakeholders to the future, faster.

For more details about the company, check out its factsheet.

#4 Divi's Laboratories

Fourth on the list is Divi's Laboratories.

Divi's Laboratories is an Indian pharmaceutical company and producer of active pharmaceutical ingredients and intermediates.

It manufactures and custom synthesises generic APIs, intermediates, and nutraceutical ingredients. The company is headquartered in Hyderabad.

Divi's Lab has n RoC of 28.7% and an earnings yield of 1.7%.

The company's revenue has grown at a CAGR of 21.7% over the last 3 years and net profit at a CAGR of 31.3%.

For the December 2021 quarter, Divi's reported a 46.5% YoY increase in revenue and a 92% YoY increase in net profit.

The company has planned a capex of around Rs 10-20 bn in the next two years depending on its investments in greenfield and brownfield projects.

There are some farmer and government-related issues causing delays in the development of its Kakinada facility. However, it intends to start work immediately once it's handed over the land.

For more details about the company, check out its factsheet.

#5 Indus Towers

The last name on the list is Indus Towers.

The company is engaged in the business of setting up, operating, and maintaining wireless communication towers.

It has a tower market share of 31% and tenancy market share of 42%. This makes it leader in the telecom tower industry in India.

Its customers are Bharti Airtel, Vodafone Idea, and Reliance Jio Infocomm.

Indus Towers has a RoC of 27.2% and an earnings yield of 5%.

The company's sales have grown at a CAGR of 28.2% and net profit at a CAGR of 34.7%.

In its latest quarterly results, Indus Towers reported a 3% YoY increase in revenue and 16% YoY increase in net profit as telcos added more locations to tap decent data demand amid the pandemic.

The company has added over 9,000 towers in the past year. With the expected launch of 5G in near term, tower addition could accelerate.

Moreover, the company may add towers in under-penetrated areas and will also continue to invest in maintenance and upgradation of existing towers and undertake energy-efficient initiatives to curb diesel consumption. Annual capex is projected at over Rs 50 bn for the medium term.

For more details about the company, check out its factsheet.

Snapshot of top stocks that pass the Joel Greenblatt filter from Equitymaster's stock screener

Here's a quick view at the above-mentioned companies based on some crucial financial parameters.

Please note that these parameters can be changed according to your selection criteria.

This will help you identify and eliminate stocks that are not meeting your requirements and emphasise those stocks that are well inside the metrics.

Why you should invest in magic formula stocks

The magic formula investing strategy is tried and tested.

It combines Warren Buffett's quality measures with Benjamin Graham's deep value approach. It has worked for many fund management companies in the past and continues to do so.

However, like all strategies, it has its limits.

The magic formula only applies to companies with a market capitalisation greater than US$100 m. Therefore, it excludes small-cap stocks. It also excludes financial companies and utility companies.

If you plan to invest in any magic formula stocks, assess the fundamentals and prospects of the business. Sustained research must not be compromised despite the positive odds.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...