We recently published a list of 10 Best Magic Formula Stocks for 2025. In this article, we are going to take a look at where Broadcom Inc. (NASDAQ:AVGO) stands against other best magic formula stocks for 2025.
The Magic Formula, as defined by Joel Greenblatt in his book The Little Book that Beats the Market, entails evaluating companies based on two metrics: earnings yield (EBIT/enterprise value) and return on capital. Greenblatt is one of the few fund managers who have regularly achieved double-digit percentage returns during their careers on Wall Street. His former business, Gotham Capital, had an incredible run from 1985 until 1994. During this time, the fund generated a net return of 34%. That said, even he was conscious that this method seemed too wonderful and easy to be true, which is why, throughout his book, he frequently questions the reader: what is the assurance, if any, that this investment technique genuinely works and is not just a fluke? In any case, he frequently underlines that the Magic Formula investment technique does not encourage investing in firms with average or low return on capital since the strategy creates a rating system to identify top companies with the best return on capital and earnings yield.
However, like with any method, there is some risk involved, and the Magic Formula does not ensure success. Since the strategy is based on past data, it’d be difficult to say if it could work well in the future, especially if market conditions change. Incidentally, a backtest of market performance from 2003 to 2015 found that the Magic Formula approach produced annualized returns of 11.4%, while the S&P 500 produced returns of 8.7%, thus failing to live up to Greenblatt’s inflated claims despite beating the benchmark. Greenblatt himself admits that the Magic Formula fails in many cases and performs poorly in some others, particularly when the holding time is too short. The investor stated the following:
“Most people just won’t wait that long. Their investment time horizon is too short. If a strategy works in the long run (meaning it sometimes takes three, four, or even five years to show its stuff), most people won’t stick with it. After a year or two of performing worse than the market averages (or earning lower returns than their friends), most people look for a new strategy— usually one that has done well over the past few years. Even professional money managers who believe their strategy will work over the long term have a hard time sticking with it.”
More recently, however, Joel Greenblatt’s fund appears to have lagged behind the overall market as a result of his investment strategy. As of the end of January, the Gotham Large Value Fund (GVALX) has only returned 10.86% over the last five years, while the S&P 500 has returned 15.17%. Nonetheless, the Magic Formula is one of many investment strategies that investors can opt for as they navigate the stock market.
Our Methodology
To make our list of the best Magic Formula stocks, we ranked the stocks in Gotham Asset Management’s Q4 2024 SEC filings by their stake value and picked out the most valuable holdings.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 373.4% since May 2014, beating its benchmark by 218 percentage points (see more details here).
A technician working at a magnified microscope, developing a new integrated circuit.
Broadcom Inc. (NASDAQ:AVGO)
Number of Hedge Fund Holders: 161
Gotham Asset Management’s Q4 2024 Stake: $49.9 million
Broadcom Inc. (NASDAQ:AVGO), one of the world’s leading technological companies, has a significant presence in both hardware and software. The company’s key competence is in offering networking and custom chips for a wide range of applications.
Broadcom Inc. (NASDAQ:AVGO) reported $14.05 billion in revenue for the fourth quarter of 2024, representing a 51% year-over-year gain. AI sales increased 220% from the previous year to $12.2 billion, while semiconductor revenue reached a new high of $30.1 billion. The company’s cutting-edge AI XPUs and Ethernet networking solutions were considered the primary drivers of this growth.
Citi maintained a Buy rating and $220 price target on Broadcom Inc. (NASDAQ:AVGO) on January 13, despite anticipated regulatory headwinds. The firm expressed worry over recent allegations that there might be more limitations on AI chip shipments to China. Notably, Bytedance, AVGO’s third-largest ASIC client, may be harmed by these limits, possibly affecting $2-$3 billion in fiscal year 2025 sales, or 3%-5% of the company’s estimated sales for the year. Nonetheless, even with uncertainties centered on government policy, Citi remains optimistic about Broadcom’s prospects. While the firm recognizes the difficulty of anticipating government initiatives, it believes that overall growth in the AI sector would more than make up for any potential loss of sales to Bytedance.
Aristotle Atlantic Partners, LLC made the following comment about AVGO in its Q4 2024 investor letter:
Broadcom Inc. (NASDAQ:AVGO) contributed to performance in the fourth quarter as the company’s third quarter results demonstrated continuing strength for its AI networking and custom accelerator semiconductor business. The company also gave long-term guidance for the service addressable market (SAM) opportunity for its AI-related business, indicating a market opportunity of $60 billion to $90 billion, which only includes contributions from its current three customers. This long-term outlook for AI semiconductor content exceeded investor expectations. Broadcom’s quarterly results also showed the company is ahead on its VMware integration timeline to achieve $8.5 billion in EBITDA, which will support long-term gross and operating margin expansion for the company.
Overall, AVGO ranks 8th on our list of best magic formula stocks for 2025. While we acknowledge the potential of AVGO as an investment, our conviction lies in the belief that certain AI stocks hold greater promise for delivering higher returns, and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than AVGO but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.