In this piece, we will take a look at the ten best magic formula stocks for the rest of 2024.
One of the best known investment strategies on Wall Street, and one that’s also followed by investing greats the like of Warren Buffett of Berkshire Hathaway and Seth Klarman of Baupost Group is value investing. Another fund manager who has delivered fantastic returns through a value based approach is Joel Greenblatt. Greenblatt currently runs the hedge fund Gotham Asset Management, a fund that he set up in 2008 after moving forward from his previous fund called Gotham Capital.
Greenblatt is among the fund managers that have consistently delivered double digit percentage returns during their career on Wall Street. His previous firm, Gotham Capital, had an amazing run between 1985 and 1994. During this time period, the firm delivered a net return of 34%. This was particularly impressive, as 1985 was the year in which Gotham Capital was founded. On an annualized basis, the fund’s returns were even stronger, since during the same period, Greenblatt’s fund delivered 50% in returns.
The hallmark of a value investing strategy, as you’ll understand if you study Warren Buffett’s investment strategy in detail, is patience. This also applies to Greenblatt, who typically waits for at least a couple of years after making an investment to reap the returns. But while patience might be a virtue, on Wall Street, it’s the returns that matter. On this front, Greenblatt hasn’t disappointed, as his fund’s blazing run in the 1980s wasn’t its only one. After setting up Gotham Asset Management in 2008, the value investor managed multiple funds. Two of these were the Gotham Absolute Return (AR) fund and the Gotham Neutral fund. Among these, the AR fund was set up in 2012, and between then and 2018, its returns sat at 58.6%.
However, while these returns are impressive, this period was filled with ups and downs for the investment vehicle. For instance, 2013 was one of the best years for this fund as it posted 29.82% in returns. These gains were trimmed down to 9.31% in 2014. While these weren’t as strong as the previous year’s performance, they were nevertheless in the green. This is important since the next year wasn’t great by any account, since in 2015, the AR fund ended up with -10.25%. 2016 was somewhat turbulent for American stock markets since the Brexit vote in the UK, slowing Chinese GDP growth, and a commodities slump led to US and global stocks dipping between the end of 2015 and the first half of 2016. Between June 2015 and late February 2016, the blue chip Dow index had lost roughly 9% and the broader NASDAQ had bled a much higher 11%.
The next year would see Greenblatt bounce back. In 2016, the fund delivered 7.97% in returns and accelerated its performance later on through posting 10.03% in gains. During these same years, i.e., in 2014, the Gotham Neutral fund’s annualized returns had sat at 6.83%.
Since the onset of the coronavirus pandemic in late 2019, the stock market has been operating in a changed environment. The pandemic’s immediate aftermath saw major stock indexes crash by 30%+, which then led to the Federal Reserve reducing rates to near zero levels. The subsequent low cost of capital, the boom in demand for consumer technology products, and the rise in retail investing then saw markets soar. During this time period, i.e., the bottom in March 2020 and the peak of December 2021, Greenblatt’s AR fund was up by 55% while the flagship S&P index gained 103%. This might make you think that perhaps the investor, who calls his investment approach a ‘Magic Formula’ had lost its magic.
But you’d be wrong. The magic of the Magic Formula was visible during the next phase of the stock market. This was marked by the Federal Reserve’s rapid interest rate tightening cycle that came in response to soaring inflation. Between December 2021 and October 2023, inflation continued to rise, as the interest rates took their sweet time to make a mark. This meant that the flagship S&P was down by 13.6% from 2021 close to the end of October 2023.
However, during the same period, the AR fund had gained 3.41%. A short strategy had helped Greenblatt, it seems, as the AR fund advertises itself as being 50% to 60% net long. Gotham’s pure play long fund, which is 100% long, led the S&P in losses during this time period as it had lost 15.52% during the same period and a stronger 27% from its peak in November start. However, the magic was visible between the March bottom and the November 2021 peak as during this period the 100% long fund had gained 97% to nearly match the flagship index.
Before we head to our list of the best Magic Formula Stocks, it’s also important to take a brief look at what this investment technique entails. Greenblatt’s strategy is based on two metrics, the return on capital employed (ROCE) and the earnings yield. In a simple implementation, stocks are ranked according to these metrics, and the top stocks are bought and held for the long term. A specialty implementation is what Gotham calls its Gotham Yield. According to the fund, this is a proprietary technique that assesses a firm’s “pre-tax cash flow, return on capital, and enterprise value.”
With these details in mind, let’s take a look at the ten best magic formula stocks to buy.
Joel Greenblatt of Gotham Asset Management
Our Methodology
To make our list of the best magic formula stocks to buy, we ranked the stocks present in Gotham Asset Management’s Q2 2024 SEC filings by their dollar value and picked out the most valuable holdings.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
10. Johnson & Johnson (NYSE:JNJ)
Number of Hedge Fund Investors In Q2 2024: 80
Gotham Asset Management’s Q2 2024 Stake: $31.8 million
Johnson & Johnson (NYSE:JNJ) is an American pharmaceutical giant that is headquartered in New Brunswick, New Jersey. One of the biggest pharmaceutical and general well being companies in the world, it benefits from a robust supply chain, diversified markets, and the resulting economies of scale. However, this also means that in case it makes a mistake, the costs are high. This has been the case in 2024 as Johnson & Johnson (NYSE:JNJ) has struggled to settle with consumers who were affected by its talcum powder. It has agreed to pay $700 million as settlements, and the dispute moved forward in August when Johnson & Johnson (NYSE:JNJ) sources claimed that the firm could announce bankruptcy to help with the whopping $6.4 billion in lawsuits that it is facing. However, Johnson & Johnson (NYSE:JNJ)’s size, as evidenced by its cash and equivalents of $ means that it can focus on growth initiatives while it battles mega lawsuits. In 2024, it announced a cumulative of $15 billion of acquisitions and rights purchases that include two medical device companies and a skin disease drug. These growth initiatives are important since Johnson & Johnson (NYSE:JNJ) might lose exclusivity rights to its arthritis drug Stelara in 2025.
Johnson & Johnson (NYSE:JNJ)’s management shared details for its medical device growth plans during the Q2 2024 earnings call:
“Turning to MedTech, we continue to advance our pipeline, launch new commercial products and integrate strategic acquisitions that broaden and further differentiate our portfolio. In cardiovascular, we are enhancing our portfolio and shifting into higher growth markets through strategic acquisitions such as Shockwave Medical. In May, we announced the launch of our CARTO 3 Version 8 electroanatomical mapping system. This is the latest version of our 3D heart mapping system, which has machine learning capabilities that increase efficiency, reproducibility, and accuracy in maps electrophysiologists use to treat atrial fibrillation and other arrhythmias. In pulsed field ablation, we initiated the commercial launch of the VARIPULSE platform in the EU and Japan receiving early positive physician feedback in the external evaluation period.
We also delivered results from the pivotal phase of the admIRE trial, where the VARIPULSE platform demonstrated 85% peak primary effectiveness with minimal adverse events, short PFA application times and low fluoroscopy exposure. In orthopedics, we received 510(k) FDA clearance for the clinical application of the VELYS Robotic-Assisted Solution in unicompartmental knee arthroplasty. This is designed for both medial and lateral procedures enabling surgeons to guide precise implant placement without a CT scan. In surgery, we launched the ECHELON 3000 in the U.S., which combines 3D stapling and gripping surface technology to enable greater staple line security. This has been shown to deliver 47% fewer leaks, reduce surgical risks and improve surgical outcomes.”
9. Broadcom Inc. (NASDAQ:AVGO)
Number of Hedge Fund Investors In Q2 2024: 130
Gotham Asset Management’s Q2 2024 Stake: $32.6 million
Broadcom Inc. (NASDAQ:AVGO) is a diversified technology company whose businesses range from semiconductor design to software as a service (SaaS). This provides it with one of the widest moats in the technology industry. Semiconductor design is all the buzz on Wall Street, particularly due to AI GPU giant NVIDIA’s $3 trillion dollar valuation. While Broadcom Inc. (NASDAQ:AVGO)’s $752 billion valuation is less than a third of NVIDIA’s, it benefits from being exposed to a broader set of industries. The firm’s modems, radios, application specific integrated chips (ASICs), and other products are used in smartphones, satellite applications, and other computing equipment. This means that Broadcom Inc. (NASDAQ:AVGO) is one of the most well heeled chip designers on the planet, and this can benefit it in the artificial intelligence race. This led to a 15% share price jump in June when management shared that the firm could earn $11 billion in annual revenue from AI chips (particularly through ASICs) compared to the earlier estimate of $10 billion. Broadcom Inc. (NASDAQ:AVGO)’s cybersecurity business provides it with a high margin division and stable recurring revenue in an industry that is expected to grow at a CAGR of 14.3% between 2024 and 2032 for a final value of $562 billion.
Aristotle Atlantic Partners mentioned Broadcom Inc. (NASDAQ:AVGO) in its Q2 2024 investor letter. Here is what the fund said:
“Broadcom is a global technology leader that designs, develops and supplies a broad range of semiconductor and infrastructure software solutions. The company strategically focuses its research and development resources to address niche opportunities in target markets and leverage its extensive portfolio of U.S. and other patents and other intellectual property to integrate multiple technologies and create system-on-chip component and software solutions that target growth opportunities. Broadcom designs products and software that deliver high performance and provide mission-critical functionality. The company has a history of innovation in the semiconductor industry and offers thousands of products that are used in end products such as enterprise and data center networking, home connectivity, “set-top boxes broadband access”, telecommunication equipment, smartphones and base stations, data center servers and storage systems, factory automation, power generation and alternative energy systems, and electronic displays. Broadcom differentiates itself through its high-performance design and integration capabilities and focuses on developing products for target markets where it believes it can earn attractive margins.
We view Broadcom’s semiconductor business as being very well positioned to benefit from secular growth in data center networking, which is being driven by AI and cloud computing. The company continues to invest in research and development, and we see this as a competitive advantage for the company. Broadcom’s infrastructure software business is a recurring revenue business model that provides mission-critical mainframe support software to its customer base. The recent VMware acquisition will enhance this business strategy and accelerate the growth rate of this business unit, as VMware’s product suite includes key tools for AI server upgrades. Our long-term investment thesis is supported by Broadcom’s success in its strategy of maintaining technology and market share leadership in mission-critical markets with high switching costs and deep profit pools.”