Stockpickr: Signs of Life in Post-Selloff Rubble - TheStreet

Known as the "investor fear gauge," the market volatility index, or VIX, was up over 60% Tuesday -- its largest move in over nine years. The markets were crushed in a post-China-crash frenzy that woke up all of the traders hypnotized by the low volatility of the past few years.

The key here is to find quality stocks trading at cheap prices and to stay focused on the primary advantage a retail investor has over an institutional investor: Your performance doesn't have to be positive every day or every month.

Let's take a look at superinvestor Joel Greenblatt, the pioneer behind Gotham Capital, two excellent value investing books, and the Magic Formula methodology.

Founded in 1985 with $7 million, Gotham Capital compounded at 50% per year for its first 10 years since inception, before fees but after expenses. After 1995, Gotham returned capital to all those who were not limited partners, and, as such, the returns were harder to come by.

Gotham Capital's holdings

can be found on Stockpickr. (

Greenblatt's sister Linda

has a several-hundred-million-dollar retail-focused hedge fund that we keep track of as well. Despite having $170 million to invest, she owns just two stocks.)

Greenblatt's books,

You Can Be a Stock Market Genius

and

The Little Book That Beats the Markets

, are well known among value investors as helpful books with cheesy titles.

You Can Be a Stock Market Genius

is the more complicated of the two, focused on special investing situations, such as purchasing spinoffs and studying reorganizations.

The Little Book That Beats the Markets

is a book Greenblatt wrote for his kids to learn investing; it is much easier to read and follow than his first book.

The Little Book That Beats the Markets

advocates an approach known as Magic Formula investing, which is essentially a quantitative stock-picking approach that attempts to find high-quality companies trading at a discount.

According to Greenblatt's book, the Magic Formula has returned 20%-plus per year fairly consistently. There are several portfolios on Stockpickr that track various aspects of the magic formula.

In this article, I want to focus on the

Dogs of the Magic Formula

: the 10 stocks that have been crushed over the past year that now meet the other criteria, which are described below.

Additionally, Stockpickr also tracks

20 Magic Formula stocks

.

The Magic Formula has two inputs -- pretax earnings yield and ROIC (return on invested capital). The pretax earnings yield is found by dividing EBIT, or earnings before interest and taxes, by EV, or enterprise value, and is used as a measure of valuation.

Theoretically, all things being equal, a company with a 10% earnings yield is cheaper -- that is, a better investment -- than a company with a 5% earnings yield.

ROIC, on the other hand, is used to judge a company's quality and management's ability to allocate capital. A company with a 10% ROIC would earn 10 cents on every dollar it invests in the business. Therefore, a company with a 15% ROIC has wiser management and is of higher quality than a company with an ROIC of only 5%, all things being equal.

Let's examine three of the companies that make up the Dogs of the Magic Formula portfolio.

OmniVision Technologies

(OVTI)

makes the chips found in many camera phones. Worries about an inventory glut have pushed shares lower over the past year. However, that said, the company has a 23% pretax earnings yield and an 80% return on invested capital. The balance sheet is pristine with $355 million in cash and no debt.

OmniVision has also appeared on a few recent lists, including

Forbes'

list of

stocks that are down but not out

, as well as in the portfolio of

Volatile Asset Management

.

True Religion Apparel

(TRLG)

, which makes high-quality jeans, has been hit hard lately on an earnings shortfall.

True Religion Apparel (TRLG)

True Religion has a forward price-to-earnings ratio of just 13 and a 100% return on invested capital. Additionally, it has $35 million in cash and no debt. The stage is also set for a short squeeze, with more than 44% of the outstanding shares sold short.

Top-performing mutual fund

Bridgeway Micro-Cap

owns shares of True Religion, and the stock also made the list of

Brean Murray's Top Picks for 2007

.

Gaming company

Cryptologic

( CRYP) has been hit hard by recent U.S. legislation that puts a complete clamp on all online gambling. Canada-based Cryptologic sells the software used by many offshore gaming sites.

Although the company's revenue and earnings have been severely hit by the new laws, it's worth noting that it has been diversifying away from onshore revenue for the past five years. For instance, it just sold a license for its online poker software to an offshore gambling site owned by

Playboy

.

With a $323 million market cap and $126 million in cash, Cryptologic has an enterprise value of $196 million. It is expected to earn $1.18 a share next year, giving it a forward P/E of 20.

Super-deep-value investor

Mohnish Pabrai

recently disclosed in a

Securities and Exchange

filing that he owns shares of Cryptologic. Pabrai is a very Buffett-esque investor; I profiled and interviewed him for my book

Trade Like Warren Buffett

. Mohnish also owns shares of

Berkshire Hathaway

( BRKA),

Universal Stainless

(USAP) - Get Report

and several other names.

Additionally, the

Cheetah Capital Value Fund

holds Cryptologic in its portfolio. Its comment on Cryptologic is that the company "is perceived incorrectly as a high-risk, volatile stock, although it is very profitable, still growing rapidly and, most importantly, is selling at huge discount to intrinsic value." Cheetah also owns shares of

KongZhong

(KONG)

; crushed lender

New Century Financial

(NEW) - Get Report

; and the "Canadian Buffett,"

Fairfax Financial

( FFH).

Check out Stockpickr's full list of the

Dogs of the Magic Formula

. Additionally, we have two other portfolios that keep track of various aspects of the Magic Formula system, including the

top dividend yielding stocks

among the Magic Formula winners and the

top 20 Magic Formula stocks

.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Cryptologic, KongZhong and True Religion Apparel to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Altucher and/or his fund had no positions in stocks mentioned, although positions may change at any time.

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of

Trade Like a Hedge Fund

and

Trade Like Warren Buffett

. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback;

click here

to send him an email.

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