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MagicDiligence (< 20)

3 Attractive Magic Formula Tech Stocks

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June 22, 2011 – Comments (0) | RELATED TICKERS: AAPL , ATVI , MIPS.DL

The Magic Formula Investing (MFI) strategy is simply a ranking system. Any particular universe of stocks can be ranked in the strategy's fashion - a composite of highest earnings yield and highest adjusted return on capital, both factors equally weighted. You can apply the strategy to rank any "basket" of stocks, ranging from entire exchange listings (or groups of exchange listings), to a pre-screened list of stocks, and so forth. The possibilities are limitless.

The official MFI site allows users to rank all U.S.-listed stocks, separated only by minimum market cap. So, for example, choosing the top 50 stocks with a minimum of $100 million market cap will produce a much different list than choosing the top 50 with a minimum $1 billion market cap. This is useful, as many investors are uncomfortable buying issues of thinly traded, micro-cap stocks that they may not familiar with (even though small-caps, historically, have drastically improved performance).

MagicDiligence uses three screens in particular to search for stocks to recommend: the top 50 stocks over $50 million market cap (the "small cap" screen), the top 50 over $1 billion ("mid cap"), and the top 30 over $3 billion ("large cap"). By combining the three, we get a good mix of cheap, quality stocks ranging from tiny unknown firms like telecommunications billing software provider MIND CTI (MNDO) to ultra large caps like diversified software maker Microsoft (MSFT).

However, sticking to these three screens means that occasionally a few stocks will slip through the cracks. Setting out to find these, I ran several "in-between" screens: the top 50 over $250 million, top 50 over $2 billion, and finally, the top 50 over $5 billion market cap. While there were a number of in-between stocks (about 15 or so), this article will highlight 3 of them that may deserve additional attention from value investors.

MIPS Technologies (MIPS)

Market Cap: $350 million

MFI Earnings Yield / PE Ratio: 10% / 15

MFI Return on Capital: 426%

Cash / Debt / Current Ratio: $108 million / $0 / 7.0

Comments: MIPS is a company very similar to market darling ARM Holdings (ARMH), licensing proprietary embedded processor cores based on the MIPS architecture and instruction set. While it once was a prime contender to be the dominant small-form architecture, over the last decade MIPS has fallen far behind, and has been mostly confined to applications such as set-top boxes, wireless routers, and so forth. However, MIPS has begun making inroads into the tablet and smartphone markets recently, and in Q3 reported a 15% increase in revenue and 21% increase in devices under license. With no debt, a cheap price, and improving results, MIPS could be worth a look. It has traded over $18 in the past year, almost triple the current price of about $6.70.

Activision Blizzard (ATVI)

Market Cap: $12.8 billion

MFI Earnings Yield / PE Ratio: 9.1% / 25.9

MFI Return on Capital: 455%

Cash / Debt / Current Ratio: $3.4 billion / $0 / 2.3

Comments: The largest video game publisher in the world, it also has probably the most diverse set of properties in the business, ranging from addictive online multiplayer offerings like World of Warcraft to acclaimed first-person war shooters in the Call of Duty series to third-party licenses to create video games based on Marvel characters like Spider-Man. Activision has a fortress for a balance sheet, the best CEO in the industry in Bobby Kotick, and its primary competition are poorly run companies like Electronic Arts (ERTS) and Take Two (TTWO). Video gaming has historically been a cyclical business, and the industry seems to be going through a current lull. However, with both the Playstation 3 and Xbox 360 over 5 years old now, a console refresh is due to take place within the next 2 years. The stock is historically cheap right now.

Apple (AAPL)

Market Cap: $301 billion

MFI Earnings Yield / PE Ratio: 9.0% / 15.5

MFI Return on Capital: 54%

Cash / Debt / Current Ratio: $29 billion / $0 / 1.9

Comments: Apple grew revenues an unbelievable 83% (from a $14 billion dollar base!) in Q2, the iPad has replicated the iPod's success and absolutely dominated the tablet market, and the iPhone is entrenched as one of the premier smart-phone platforms. At the same time, the Mac saw unit increases of 28% in Q2, while the PC market declined, continuing a now 5-year trend of market share gains. What else can the company do? Its new iCloud platform is a useful and clever lock-in mechanism that will increase switching costs for customers. An iPhone refresh in the Fall is set to provide yet another sales catalyst. Steve Jobs' health is a valid concern, but this remains the best company of this generation, and at just 15 times earnings, the stock is on sale.


Steve owns no position in any stocks discussed in this article

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