We recently The 10 Most Promising Magic Formula Stocks for the Remaining Year of 2024. In this article, we'll take a look at how NVIDIA Corporation (NASDAQ:NVDA) stands relative to other Magic Formula stocks.
It is one of the most well-known investment strategies on Wall Street and is also followed by some of the biggest investment giants, including: Berkshire Hathaway's Warren Buffett and Seth Klarman of the Baupost Group Value investing. Another fund manager who has seen impressive returns through a value-based approach is Joel Greenblatt. Greenblatt currently runs the hedge fund Gotham Asset Management, which he founded in 2008 after moving on from his previous fund, Gotham Capital.
Greenblatt is one of those fund managers who has consistently delivered double-digit percentage returns throughout his career on Wall Street. His previous firm, Gotham Capital, had an incredible run from 1985 to 1994, when the firm delivered a net return of 34%, which was especially impressive since 1985 was the year Gotham Capital was founded. On an annualized basis, the fund's returns were even higher, with Greenblatt's fund delivering a 50% return during the same period.
You will understand the characteristics of a value investing strategy A closer look at Warren Buffett's investment strategiespatience. This is true for Greenblatt too. He usually waits at least two years between making an investment and getting a return. But while patience may be a virtue, on Wall Street, returns matter. In this regard, Greenblatt does not disappoint, and while his fund saw rapid growth in the 1980s, it was not its only success. After founding Gotham Asset Management in 2008, the value investor managed multiple funds. Two of them are the Gotham Absolute Return (AR) fund and the Gotham Neutral fund. Of these, the AR fund was launched in 2012, and since then, it has returned 58.6% up to 2018.
However, while these returns are great, this period was full of ups and downs for the investment vehicle. For example, 2013 was one of the best years for the fund, with a return of 29.82%. This gain dropped to 9.31% in 2014, which was not as strong as the previous year's performance, but still positive. This is important because the following year was not a great year in any sense. In 2015, the AR fund ended with a -10.25% return. 2016 was a somewhat volatile year for the US stock market, as the UK vote to leave the EU, slowing GDP growth in China, and weak commodity prices caused US and global stocks to fall in late 2015 and early 2016. From June 2015 to late February 2016, the blue-chip Dow Jones Industrial Average fell by about 9%, while the Nasdaq Composite Index fell an even higher 11%.
The following year, Greenblatt recovered: The fund returned 7.97% in 2016 and accelerated performance thereafter, earning a 10.03% gain. In the same year, 2014, the Gotham Neutral fund returned 6.83% annualized.
Since the coronavirus pandemic began in late 2019, the stock market has been operating in a changed environment. In the aftermath of the pandemic, major stock indexes crashed by more than 30% and the Federal Reserve slashed interest rates to near zero. The market then soared due to lower capital costs, surging demand for consumer technology products, and rising retail investment. During this period, from its trough in March 2020 to its peak in December 2021, Greenblatt's AR fund rose 55%, while the flagship S&P index rose 103%. This may leave investors who call their investment methodology a “magic formula” wondering if they've lost the magic.
But that's wrong. The magic of the magic formula became apparent in the next phase of the stock market, which was marked by the Federal Reserve initiating a rapid interest rate tightening cycle in response to surging inflation. Between December 2021 and October 2023, interest rates took their time to take effect and inflation continued to rise, meaning the flagship S&P ended up down 13.6% from 2021 by the end of October 2023.
However, over the same period, the AR fund rose 3.41%. The AR fund advertises that it is 50% to 60% net long, and the short strategy appears to have worked in Greenblatt's favor. The 100% long Gotham Pure Play Long fund lost 15.52% over the same period, and a strong 27% loss from its peak in early November, leading the S&P's losses during the period. However, the magic was seen between the March bottom and the November 2021 peak, during which the 100% long fund made a gain of 97%, nearly matching the flagship index.
Before we move on to our list of the best Magic Formula stocks, it's also important to take a quick look at what this investment technique entails. Greenblatt's strategy is based on two metrics: return on invested capital (ROCE) and earnings yield. In a simple implementation, stocks are ranked according to these metrics, and the top-ranking stocks are purchased and held for the long term. A specialized implementation is what Gotham calls the Gotham Yield. According to the fund, this is a proprietary methodology that evaluates a company's “pre-tax cash flow, return on capital, and enterprise value.”
Our Methodology
To create a list of the best Magic Formula stocks to buy, we ranked the shares listed in Gotham Asset Management's Q2 2024 SEC filing by dollar value and picked out the most valuable holdings.
We also mentioned the number of hedge fund investors in these stocks. Why do we care about the stocks that hedge funds invest in? The reason is simple: our research shows that you can beat the market by mimicking the top holdings of the best hedge funds. Our quarterly newsletter strategy selects 14 small and large stocks each quarter and has returned 275% since May 2014, beating the benchmark by 150 percentage points (Learn more).
Close-up of a colorful high-end graphics card plugged into a gaming computer.
NVIDIA Corporation (NASDAQ:NVDA)
Number of hedge fund investors in Q2 2024: 179
Gotham Asset Management Q2 2024 holdings: $192 million
NVIDIA Corporation (NASDAQ:NVDA) is the top stock on the stock market when it comes to artificial intelligence. The company's competitive position is based on its GPU design, and NVIDIA Corporation (NASDAQ:NVDA) chips are widely recognized as the best in the industry. This has created an insatiable demand for NVIDIA Corporation (NASDAQ:NVDA) GPUs, which has caused the company's revenue to grow from $16.7 billion in 2021 to $79.7 billion over the past 12 months. This represents 377% growth on an absolute basis, and during the same period, NVIDIA Corporation (NASDAQ:NVDA) shares have risen 299% after paring their gains since July. By July, before NVIDIA Corporation (NASDAQ:NVDA) announced its fiscal second quarter 2025 results, the company's shares had risen 339%. NVIDIA Corporation (NASDAQ:NVDA) has few alternatives to fall back on for revenue because its business is solely dependent on GPUs, making it vulnerable to inventory disruptions and oversupply. At the same time, the company's technological prowess means that alternative GPUs are hard to come by, and the world continues to rely on NVIDIA Corporation (NASDAQ:NVDA) for the best GPUs.
Baron Funds has invested in NVIDIA Corporation (NASDAQ:NVDA) Q2 2024 Investor LetterThe fund stated:
“But recently, we have entered a period of doubt and questioning, some of which is real and normal in the early stages of a new paradigm, but some of which is driven by short sellers. Given the explosive returns of NVIDIA and other AI leaders, AI bears and fear mongers have compared the current AI market winners to the Internet bubble of the late 1990s and early 2000s, and NVIDIA's current stock price movement to Cisco's stock price movement at that time. First, before the Internet bubble burst, many stocks were trading at exorbitant valuations and based on manufactured metrics (such as price per viewer), but as we have said many times, the Internet transformed our world and created the digital age we live in today. Second, while the inflection point in NVIDIA's stock price was unprecedented for a company of its size, it was driven almost entirely by explosive growth in revenue, earnings and cash flow, not an expansion in multiples. Over the past 12 months, NVIDIA's stock price has effectively tripled, while its forward P/E ratio has risen 1.2% year-on-year. The multiple remains essentially flat. This is because NVIDIA has far outperformed Wall Street expectations, even though it is covered by over 60 sell-side analysts and has been increasing its future forecasts every quarter. The only other time in my career that this has happened was when Apple first introduced the iPhone and surprised Wall Street with its growth. In contrast, most of Cisco's moves in the late 1990s were due to expanding multiples. At its peak, Cisco had a P/E multiple of over 130x, more than four times its five-year average of 37x. NVIDIA's P/E multiple at the end of the second quarter was 40x, the same as its five-year average, with a P/E growth ratio (PEG) of 0.8x to 2025, and consensus estimates call for NVIDIA to grow earnings per share by 40% next year.
Additionally, there are concerns among investors about the financial impact that AI is having and whether the exponential capital expenditures (CAPEX) across the tech industry, especially the big cloud players known as hyperscalers (Microsoft, Google, Amazon, Meta), can be justified and get a reasonable return on invested capital (ROIC). First, the adoption and penetration of new technologies typically follows a classic S-curve. More precisely, in our view, it is a series of S-curves or phases. For at least the last year and a half, we have been in the AI infrastructure building phase, or as NVIDIA CEO Jensen Huang put it, building AI factories. This phase has been dominated by infrastructure layer players (fast computing chip suppliers like NVIDIA and Broadcom, data center, cloud infrastructure, and energy companies). The hyperscalers, other companies, and nation states with upfront investments understand that if they want to get in the AI game, they need to invest now to build infrastructure and build factories. If we don't, we'll find ourselves chaotically sitting on the sidelines or playing catch-up in the biggest game of all — the most important race of a technology generation. Only those who invest today will have a chance to be the winners of tomorrow.”
Overall NVDA No.1 It's on our list of the best Magic Formula stocks to buy. While we acknowledge NVDA's potential as an investment, we believe some AI stocks have the potential to deliver higher returns in a shorter time frame. If you're looking for AI stocks that are more promising than NVDA but trade for less than 5x its earnings, check out our report. Cheapest AI Stocks.
Read next: The $30 Trillion Opportunity: Morgan Stanley's 15 Best Humanoid Robot Stocks to Buy and Jim Cramer says NVIDIA has 'become a wasteland'.
Disclosures: None. This article originally appeared on Insider Monkey.
