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5 'Magic Formula' Stocks for 2013

Stocks in this article: MHPEXPECAHPQAZO

BALTIMORE ( Stockpickr) -- What if you could use a "magic formula" to pick stocks for you? According to hedge fund manager Joel Greenblatt, you can.

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Greenblatt's "Magic Formula Investing" is a way of ranking stocks quantitatively using fundamental data. In short, it hinges on identifying firms with the highest earnings yield and the highest return on capital, and buying them with both hands. Historically, Greenblatt's magic formula has lived up to its name, producing some magical returns -- according to his work in The Little Book that Beats the Market, the strategy has earned average gains of 30.8% over the last 17 years.

The magic formula approach to investing isn't without a few pitfalls, however. For starters, the screen's focus on the highest earnings yield and return on capital tends to attract overhyped momentum names that carry a whole lot more volatility than the rest of the market. That doesn't mean that you should throw out the magic formula approach wholesale, but it does show the value of adding some qualitative filters to this quantitative strategy.

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So, that's what we're doing today with a look at five magic formula stocks to buy for 2013...

McGraw-Hill Companies

First up is specialty publishing giant McGraw-Hill Companies (MHP). While many conventional publishers fell on hard times during the recession, McGraw-Hill skirted downside by sticking to niche businesses. MHP's focus is in providing higher-value content and research through subsidiaries like J.D. Power and Associates, Standard & Poor's, and its namesake educational publishing arm.

While that focus on trade publications and education means that higher costs go into creating products, it also means that the firm can demand higher prices and deeper profit margins for its trouble. While that niche exposure spared MHP from the worst of the recession, the firm's valuable S&P ratings unit suffered some serious brand damage from its failure to spot the problems in many of the debt ratings it made. Even so, the ratings business is heavily regulated and barriers to entry are high -- new competitors aren't likely to take business away from S&P, only add more another set of ratings to the mix.

Financially, MHP has been looking more attractive than ever lately, building up a net cash position for the first time in a while. And I've already said that I think that McGraw-Hill looks like a likely candidate for a dividend hike in the next quarter as well. With shares definitively in an uptrend, this magic formula stock looks well positioned to perform in 2013.

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