A Ranking system sorts stocks from best to worst based on a set of weighted factors. Portfolio123 has a powerful ranking system which allows the user to create complex formulas according to many different criteria. They also have highly useful several groups of pre-built ranking systems, I used one of them the "All-Stars: Greenblatt" in this article. The ranking system is based on investing principles of the well-known investor Joel Greenblatt.

The "All-Stars: Greenblatt" ranking system is taking into account just two factors; Return on Capital and Earnings Yield (E/P) in equal proportions.

I recommend investors to read Joel Greenblatt impressive book "The Little Book That Beats the Market". Mr. Greenblatt proposed, what he called "the magic formula", to rank all the stocks according to just two factors; Return on Capital and Earnings Yield (E/P) in equal proportions, and to select the first twenty to thirty stocks for the portfolio.

In order to find out how such a ranking formula would have performed during the last 17 years, I ran a back-test, which is available by the Portfolio123's screener. For the back-test, I took all the 6,328 stocks in the Portfolio123's database. The back-test results are shown in the chart below. For the back-test, I divided the 6,328 companies into twenty groups according to their ranking. The chart clearly shows that the average annual return has a very significant positive correlation to the "All-Stars: Greenblatt" rank. The highest ranked group with the ranking score of 95-100, which is shown by the light blue column in the chart, has given by far the best return, an average annual return of almost 18%, while the average annual return of the S&P 500 index during the same period was about 3.2% (the red column at the left part of the chart). Also, the second and the third group (scored: 85-90 and 90-95) have given superior returns. This brings me to the conclusion that the ranking system is very useful.

Historical Performance by Ranks

After running "All-Stars: Greenblatt" ranking system on all S&P 500 stocks, on September 3, I discovered the twenty best stocks, which are shown in the table below. In this article, I will focus on the first-ranked stock; Gilead Sciences (GILD).

GILD's Stock Performance

Since the beginning of the year, GILD's stock is down 24% while the S&P 500 Index has increased 6.7%, and the Nasdaq Composite Index has gained 4.8%. However, since the beginning of 2012, GILD's stock has gained an astounding 282%. In this period, the S&P 500 Index has increased 73.3%, and the Nasdaq Composite Index has risen 101.5%. According to TipRanks, the average target price of the top analysts is at $105.2, representing an upside of 36.8% from its September 3 close price, which appears reasonable, in my opinion.

GILD Daily Chart

GILD Weekly Chart

Charts: TradeStation Group, Inc.

Valuation

Considering its compelling valuation metrics GILD's stock, in my opinion, is significantly undervalued. Gilead's trailing P/E is very low at 6.75, and its forward P/E is even lower at 6.59. The price to free cash flow ratio is very low at 7.01, and the Enterprise Value/EBITDA ratio is also very low at 5.36.

Gilead started to pay a dividend in the second quarter of 2015. The annual dividend yield is at 2.45%, and the payout ratio is only 15.2%. During the first six months of 2016, Gilead spent $9.0 billion on stock buybacks. In fact, in the last year, Gilead has spent about $11.5 billion on share repurchases, by far the highest level among all healthcare companies. In my view, the fact that Gilead has been spending such an enormous amount on share repurchases demonstrates that the company considers its stock at the current price as a bargain.

Conclusion

As I see it, Gilead's stock is considerably undervalued, and such a significant discount cannot be sustainable. Sooner or later investors will find out that the stock is currently very attractive, which will cause the stock to rise sharply. After all, Gilead has a rich pipeline of over 25 different programs under development, and it is increasing its research and development expenses. Moreover, the company generates strong free cash flow and returns substantial capital to its shareholders by stock buybacks and increasing dividend payments. The average target price of the top analysts is at $105.2, representing an upside of 36.8% from its September 3 close price, which appears reasonable, in my opinion.