Joel Greenblatt is best known for Magic Formula Investing, a quantitative strategy for picking stocks. With a fancy name, the formula mainly picks “cheap and good companies” with a high earnings yield and a high return on capital. In 2009, Greenblatt launched an online money management firm called Formula Investing. As it name shows, the company follows the “Magic Formula”. It employs a stock-screening system and a disciplined approach to manage portfolios of value stocks. The Formula Investing US Value Select A (FNSAX) returned 26% since inception, beating the S&P 500 index by over 10 percentage points. Greenblatt is also the founder of Gotham Asset Management. He founded the company in 1985 with $7 million. Today, the company has over $800 million assets under management and manages over more than 2000 accounts.
Recently, Gotham released its latest holdings in a 13F filing. In this article, we are going to take a closer look at the high dividend magic formula stocks and decide whether investors should follow these investments. If these stocks perform in line with the strategy’s past performance investors should enjoy high dividends and may be able to outperform the market as well.
Meredith Corp (MDP) is one of the high dividend positions in Gotham’s 13F portfolio. At the end of last year, Gotham had nearly $4 million invested in this position. MDP has a dividend yield of 4.51% and the company has an impressive record of increasing its dividends. It has been raising its dividend payouts for 18 consecutive years. Recently, the company significantly increased its quarterly dividends by 50% to $0.3825 per share, which was paid to its shareholders in December. We expect the company will continue to increase its dividends in the future. Though MDP’s current payout ratio of 60% is a little bit high due to its recent big increase in dividend payouts, its earnings are expected to grow at an average of about 10% annually in the next couple of years. The company has attractive valuation levels. MDP’s current P/E ratio is 13.09, versus 18.50 for its peers. Its forward P/E ratio of 11.38 is also lower than its peers’ 17.02. We are bullish about MDP. So do prominent investors. Chuck Royce’s Royce & Associates had about $90 million invested in MDP at the end of last year. David Dreman’s Dreman Value Management also invested about $40 million in this stock.
Two aerospace/defense stocks, Northrop Grumman Corp (NOC) and Raytheon Co (RTN), are among Gotham’s top 10 positions with dividend yields of above 3%. Gotham had $11 million invested in NOC and another $9 million invested in RTN. Both companies have dividend yields between 3% and 4%. NOC has a dividend yield of 3.34% and RTN’s dividend yield is 3.38%. They are also quite similar on dividend growth records, valuation levels, and payout ratios. Both of them have been increasing their dividend payouts to their shareholders for the past few years. We think they still have the ability to continue increasing their dividends because they have low payout ratios of around 30% and decent earnings growth. NOC is expected to grow at 7% per year and RTN is expected to grow at about 10%. In addition, RTN’s current P/E ratio is 9.60 and NOC’s is 8.06, much lower than the average of 18.35 for their peers. The main competitors of both companies include Boeing Co (BA) and Lockheed Martin Corporation (LMT). Both stocks have double digit P/E ratios. BA’s dividend yield is below 2.5%, but LMT has a dividend yield of over 4%. Therefore, investors who want high dividends right now may pick LMT. On the other hand, for investors who are willing to wait for higher dividends, we strongly recommend them to invest in NOC or RTN for long term. Besides Greenblatt, a few other hedge fund managers were also bullish about NOC and RTN. Cliff Asness’ AQR Capital Management also had over $70 million invested in NOC, and Ken Griffin’s Citadel Investment Group had more than $30 million invested in RTN.
Another dividend stock that Greenblatt is bullish about is Lorillard Inc (LO). At the end of last year, the fund reported owning $5.8 million worth of LO shares. Gotham also slightly reduced its position in LO by about 7%. LO has a high dividend yield of 4.77%. It also seems to be trading at a small discount compared with its peers. Its current P/E ratio is 16.23, versus 18 for the industry average. We think LO is also a good choice for dividend lovers, especially for those who need the dividend payments immediately.