In his 2005 best-selling book, “The Little Book That Beats the Market,” Joel Greenblatt (Trades, Portfolio) introduced the investing world to the Magic Formula. The simple mathematical formula is used to find profitable businesses that trade at bargain prices.
The formula ranks companies based on two primary metrics: earnings yield and return on capital. The guru, who is head of Gotham Asset Management, defines earnings yield as earnings before interest and taxes (Ebit) divided by enterprise value. The metric measures how much the company earns compared to how much the stock is valued by the market.
Meanwhile, the return on capital is calculated as Ebit divided by the sum of the net fixed assets and net working capital. The metric measures how much a company earns compared to what it spends to produce those earnings.
One way investors can search for stocks that meet the criteria for Greenblatt’s formula is through the Magic Formula Screener, a Premium GuruFocus feature. After looking for companies that have high ROC and earnings yields, the screener then ranks them.
On Monday, the National Association of Home Buildiers/Wells Fargo Housing Market Index reported the builder confidence in the single-family housing market fell five points to 45 in September. This was the first reversal in seven months as higher mortgage rates have made housing less affordable.
Further, while homebuilders are benefiting from the lack of supply on the existing sales market, they continue to grapple with a shortage of construction workers, buildable lots and distribution transformers.
Despite these headwinds, the construction industry has recorded a gain of 20.81% year to date within the broader industrials sector.
As such, the Magic Formula screener has identified a number of top-ranked homebuilders that appear to be undervalued despite the overall boost to the industry. As of Sept. 20, these included Legacy Housing Corp. (LEGH, Financial), Skyline Champion Corp. (SKY, Financial), Cavco Industries Inc. (CVCO, Financial), PulteGroup Inc. (PHM, Financial) and NVR Inc. (NVR, Financial).
Legacy Housing
In the top spot is Legacy Housing (LEGH, Financial) with an earnings yield of 15.70% and a ROC of 151.38%.
The Bedford, Texas-based company, which manufactures modular and mobile homes, tiny houses and oilfield workforce living units, has a $505.88 million market cap; its shares were trading around $20.74 on Wednesday with a price-earnings ratio of 7.86, a price-book ratio of 1.22 and a price-sales ratio of 2.21.
The GF Value Line suggests the stock is fairly valued based on its historical ratios, past financial performance and analysts’ future earnings projections.
At 91 out of 100, the GF Score indicates the company has high outperformance potential on the back of solid ratings for profitability, growth, financial strength and momentum. The value rank, however, is more moderate.
Skyline Champion
Skyline Champion (SKY, Financial) placed second with a 14.77% earnings yield and a 207.10% ROC.
The maker of factory-built homes, which is headquartered in Troy, Michigan, has a market cap of $3.83 billion; its shares traded around $67 on Wednesday with a price-earnings ratio of 11.47, a price-book ratio of 2.96 and a price-sales ratio of 1.65.
According to the GF Value Line, the stock is modestly overvalued currently.
The GF Score of 74 implies the company is likely to have average performance going forward, driven by high ratings for profitability, financial strength and momentum, middling marks for growth and a low value rank.
Cavco Industries
Coming in third is Cavco Industries (CVCO, Financial) with an earnings yield of 14.39% and a ROC of 80.99%.
The Phoenix-based designer and builder of manufactured and modular homes, commercial buildings, park model RVs and vacation cabins has a $2.39 billion market cap; its shares were trading around $275.28 on Wednesday with a price-earnings ratio of 10.76, a price-book ratio of 2.33 and a price-sales ratio of 1.20.
Based on the GF Value Line, the stock appears to be modestly undervalued currently.
The GF Score of 98 means the company has high outperformance potential. It received solid ratings for all five criteria.
PulteGroup
With an earnings yield of 20.62% and a ROC of 42.04%, PulteGroup (PHM, Financial) ranks fourth.
The residential home construction company headquartered in Atlanta has a market cap of $16.88 billion; its shares traded around $76.93 on Wednesday with a price-earnings ratio of 6.36, a price-book ratio of 1.74 and a price-sales ratio of 1.02.
The GF Value Line suggests the stock is fairly valued currently.
Supported by solid ratings for profitability, growth and financial strength, the GF Score of 91 indicates the company has high outperformance potential. Its value rank is more moderate, while momentum is low.
NVR
Rounding out the top five is NVR (NVR, Financial) with an earnings yield of 11.06% and a ROC of 91.57%.
The Reston, Virginia-based homebuilder has a $20.07 billion market cap; its shares were trading around $6,141.07 on Wednesday with a price-earnings ratio of 13.12, a price-book ratio of 4.83 and a price-sales ratio of 2.10.
According to the GF Value Line, the stock is fairly valued currently.
The company also has high outperformance potential with a GF Score of 96. It raked in high ratings for three of the criteria, but more moderate value and momentum ranks.
Other potential opportunities
Additional homebuilders that qualified for the screener included Meritage Homes Corp. (MTH, Financial), Taylor Morrison Home Corp. (TMHC, Financial), Toll Brothers Inc. (TOL, Financial), M/I Homes Inc. (MHO, Financial) and Green Brick Parners Inc. (GRBK, Financial).
