Warren Buffett is very clear that the heart of his investing philosophy is buying wonderful companies at fair prices.
While the rest of us may not possess the insight of Buffett when determining what constitutes a wonderful company at a fair price, Joel Greenblatt has simplified Buffett’s approach into an easily understandable formula.
Greenblatt’s ‘Magic Formula’ balances high returns on invested capital (a measure of business quality) with a measure of value (EBIT/enterprise value).
According to Greenblatt, and supported by evidence published more recently, the ‘Magic Formula’ beats the market.
Here are five companies that fit the profile of the type of companies that are sought by Greenblatt – companies with high returns on invested capital that represent fair value.
Macquarie Atlas Roads Limited (ASX: MQA)
Macquarie Atlas Roads own and operate toll roads, bridges and tunnels in France, the United States and Germany. The company invests in global infrastructure assets that generate stable cash flows and offer potentially resilient long-term performance through economic cycles. Based on last year’s financial reports, Macquarie Atlas Roads has a return on invested capital of 24.9%, and it currently trades at an EBIT/enterprise value of 10%.
Fortescue Metals Group Limited (ASX: FMG)
Fortescue is an iron-ore miner that produces iron ore from mines in Western Australia. The share price has come under pressure due to declining prices for its lower grade iron ore. Based on 2017 financial reports, Fortescue has a return on invested capital of almost 20%, and an EBIT/enterprise value of 22%.
Qantas Airways Limited (ASX: QAN)
Qantas Airways provides air transportation within Australia and internationally. It also sells worldwide and domestic holiday tours. The share price has rallied recently on the back of tailwinds such as lower oil prices and changing investor sentiment around airlines. In 2017 Qantas reported a return on invested capital of 19%, and currently has an EBIT/enterprise value of 13.8%.
Codan Limited (ASX: CDA)
Codan is engaged in the development of electronic solutions for government, non-government, and consumer markets. Its businesses include radio communications, metal detection, mining automation, and defence electronics. In 2017 Codan reported a return on invested capital of 93, and it currently trades at an EBIT/enterprise value of 15.8%.
Adairs (ASX: ADH)
Adairs is a retailer of manchester and homewares. The company has over 160 stores across Australia in five physical store formats, comprising Adairs, Adairs Homemaker, Adairs Kids, UHR and Adairs Outlets. Adairs last reported a return on invested capital of almost 40%, and trades at an EBIT/enterprise value of 8.7%.
These five companies offer a reasonable balance between business quality and value, typical of that sought by Warren Buffett and Joel Greenblatt. I’d be happy to buy them today with the view of capital growth throughout 2018.
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Motley Fool contributor Stewart Vella owns shares of Fortescue Metals Group Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.