I’m a fan of using screens to scan the universe for opportunities. One very popular screen is Joel Greenblatt’s ‘Magic Formula’ which he talks about in his best selling book “The Little Book that Beats the Market”. Express Scripts (ESRX) is one of the stocks given by the screen and is up more than 15% before the market opens today. This is because it was just announced that Cigna (CI) has plans to buy the company in a cash and stock deal worth $52 billion (excluding debt). Specifically, the terms of the deal are that ESRX shareholders receive $48.75 in cash and 0.2434 shares for a value of $96.03 as per yesterday’s CI closing price. Quite a bump up from $73.42 that ESRX was trading at yesterday. Merger arbitrage traders may want to put this on their watchlist as there is potential 10% gain according to entry prices. This can be achieved by buying ESRX and shorting CI (for example, long 100 shares in ESRX and short 24 shares in CI). So if the deal closes within a year, then the trader can make around 10%, however, it should be noted that some risk is involved. The deal may not get approved by the shareholders or the Department of Justice may try to block it. If that happens ESRX will drop and CI will rise and the trader will end up with a losing position. I believe there is a good chance the deal will go through. To read more see the WSJ article.
Back to the Magic Formula. This screen is a ranking system using ‘return on capital’ and ‘earnings yield’. Using Greenblatt’s definitions I re-created the screen. For specifics regarding the calculations please scroll to the bottom of the post. In the first table below you can find the top 50 ranked stocks in alphabetical order. Go through the list. Perhaps you will find the next company to be acquired 😉
As you may have noticed several companies are small or lack trading liquidity. So I ran the screen again, but I added an additional filter. All the stock in the table below trade an average of $2 million worth a day based on the average trading activity over the last 3 months.
Screens can be a great starting point but not a substitute for research. I am sure there are value traps in these tables but also opportunities. I hope the above helps and wish you the best of luck!
Some points regarding the calculations:
- Universe: All shares whose primary security is in the United States. Excluding receipts, financials, utilities, and managed care. Also excluded are stocks with a market cap less than $50m or with $0 revenue.
- Return on capital = EBIT / (Capital Employed – Short-term debt – Excess Cash)
- Capital Employed = Net Fixed Assets + Current Assets – Current Liabilities
- This approach was used in order to best replicate Greenblatt which uses Net Working Capital. It’s a workaround based on the data I have access to.
- Earnings yield = EBIT / adjusted Enterprise Value
- adjusted Enterprise Value = Enterprise Value + Underfunded Pension Liabilities
