The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.NEW YORK ( Magic Diligence) -- The safest and most reliable path to stock market success is to invest in CRAP stocks. The strategy we follow, Joel Greenblatt's Magic Formula® Investing, is a great mechanical, qualitative screen for digging up candidates. But to find the CRAPpiest of stocks, we need to get our hands dirty and dig our noses into the financial statements, conference calls, SEC filings and industry research. Only then can our portfolios come out smelling like roses. What in the heck am I talking about? Four points of research: 1. Conservatively managed The best companies are managed conservatively, and are always focused on earning high returns on capital instead of overpaying simply to grow or build an empire. By maintaining reasonable levels of debt and always having a healthy cash balance for the inevitable bumps in the road, these companies are built to last through thick and thin.
On the other hand, finding an MFI stock with good revenue growth trends could very well indicate that the market's valuation has trailed the company's growth trajectory, creating an attractive investment candidate. This is especially true if rapid sales growth is projected to continue. C&J Energy Services ( CJES) grew sales 210% in 2011 and is projected to grow another 50% this year, yet carries a price-to-earnings multiple under 6! 3. Advantages over the competition Competition will always be a keen risk, so look for firms that have structural competitive advantages. Microsoft ( MSFT) software is a lynchpin of most businesses worldwide and would be a gigantic hassle to switch away from, creating high switching costs. Tremendous scale, razor-thin margins, and an established oligarchy create huge barriers to entry for any prospective competitors of drug distributor AmerisourceBergen ( ABC). Regulatory patent protections prevent direct competition for Gilead's ( GILD) HIV drug portfolio. All of these factors can help protect pricing, market share, and profitability from competitors. On the other hand, a firm like Chemed ( CHE) has almost no structural advantages. Both their plumbing and hospice businesses face thousands of competitors, and both have low barriers for new entrants. 4. Priced well below a reasonable fair value estimate Here is where MFI helps us the most, as a high earnings yield (basically the inverse of a low P/E) is one of the components of the screen. All of these stocks are cheap against trailing earnings. But is the valuation warranted based on the prospect of a long-term decline in revenue and profit? Is it warranted based on horrific financial health? Is it warranted based on competitors (or new government regulations) eating into their business? To figure this stuff out, one needs to sit down and estimate a fair value for the business, based on reasonable estimates of future results and valuation ranges. (C)onservatively managed, (R)evenue growth, (A)dvantages over the competition, (P)riced well below fair value. When digging through heaps of stock opportunities, always be on the lookout for CRAP. I've got my shovel. How about you?