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A Canadianized Greenblatt portfolio Add to ...

What are we looking for? Yesterday, we visited a stock screen from market-data-analysis website Validea.com that mimics the strategy of Joel Greenblatt, hedge fund manager and author of the 2005 bestseller The Little Book That Beats the Market. Mr. Greenblatt's "Magic Formula," as he calls it, had back-tested average annual returns of 30.8 per cent from 1988 through 2004, compared with the S&P 500's 12.4-per-cent average. The strategy has proven the most successful over the past year among the model portfolios Validea has created to track the strategies of 12 well-known market gurus, a list including legends like Warren Buffett and Benjamin Graham.

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Yesterday's column, which listed the top 20 U.S. stocks identified by Validea under its Greenblatt-inspired Earnings Yield Investor screen, piqued readers' interest - most of whom wanted to see an equivalent Canadian screen. With the help of the stock-screening tools from Capital IQ (a division of Standard & Poor's), we're happy to oblige.

Canadian Greenblatt Screen Mr. Greenblatt's approach to stock picking is elegant in its simplicity. He only cares about two criteria: Earnings yield (annual earnings per share as a percentage of stock price, or essentially the price-to-earnings ratio flipped on its head), and return on capital. He ranks all the stocks he tracks on each of these criteria, adds the two rankings together, and the stock with the lowest total is his highest-rate stock; i.e. the stock that looks the most undervalued. (For example, if a stock ranks 10th in earnings yield and 20th in return on capital, its total score is 30.) This is the method Validea uses, applying it to its universe of U.S. stocks.

For our Canadian screen, we narrowed it to stocks listed on the S&P/TSX composite index . Following Validea's 20-stock model portfolio, we have included the top 20 Canadian stocks produced.

What did we find?

More than half the Canadian list is made up of income trusts, and the list is top-heavy in energy companies. This may be indicative of the market's continued wariness over earnings in the sector, where the strength and direction of underlying commodity prices remains uncertain.

At the top of the list is Paramount Energy Trust , whose earnings yield of a whopping 36 per cent is the best on the 209-member S&P/TSX composite, while its 18-per-cent return on capital ranks 13th. A close second is one of the biggest stocks on Canada's benchmark index, energy giant EnCana Corp. , which boasts a 20-per-cent earnings yield and an 18.6-per-cent return on capital.

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