Most of my recent focus has been on the energy sector and the small community banks. While an unlikely pairing, these two sectors have become the bulk of my investment portfolio. I maintain two separate portfolios, one of which is devoted entirely to the community banks, and energy stocks are becoming an increasingly large percentage of my separate deep-value investments. Even though I am concentrating on researching and evaluating opportunities in those two areas, it does not mean we shut everything else down. I'm still running and testing various screens and kicking over stocks in the dark corners of the market looking for opportunity.
Last night, I ran some screens based loosely on Joel Greenblatt's "Magic Formula," and the end results were pretty strong. I searched for companies that have high returns on capital both his year and over the past 10 years and have an EV/EBIT ratio of less than 7. I limited the search to U.S. companies over $50 million market cap. I was hoping this would give me a list of strong-performing companies that were currently on sale, and it worked exactly as I had hoped. Over the last 15 years, this strategy has handily beat the market and performed exceptionally well in bad markets.
There are some really intriguing companies on the current list. I have talked about Willdan Group (WLDN) before and it's a better buy today that it was last summer. The company provides consulting services in a wide range of markets including energy; infrastructure and transportation; municipal engineering, planning and staff augmentation; economic and financial analysis; and homeland security and emergency management. It's basically helping municipalities, utilities and private-sector clients navigate the complex maze of federal regulations, while the energy division focuses on efficiencies. To say long-term trends in the world favor these businesses is a dramatic understatement.
The company stumbled in the last quarter due to what management called operational issues in the energy-efficient division and the stock has come down since and currently trades at an EV ratio of just 5.8. The return on capital over the trailing 12 months is 103% and the 10-year average is 23%. Earnings have been growing by 28% a year for this company and there is no reason for that to decline anytime soon as government gets bigger and the need to operate on an energy-efficient basis remains important.
I have not yet pulled the trigger on the private equity firms, but it is getting close. Carlyle Group (CG) makes our list of high-return potential bargain stocks. The firm took some writedowns in the last quarter that hurt earnings and posted its first loss as a public company. The stock has been hit hard but investors are overlooking the fact the firm has more than $60 billion of dry powder that it can put to work in areas where assets are underpriced, like energy. One quarter is a very small period of time for a private equity investor. Given that Carlyle pays out 75% of distributable earnings each year, investors who buy at bargain levels could see fantastic dividend payouts as well as price appreciation. The firm has a return on capital of 80% and the EV/EBIT ratio is at less than 2 right now. I have not jumped into the stock yet, but I will. Carlyle has the potential to make long-term, patient investors an enormous amount of money.
I love the business MYR Group (MYRG) is in. It's an electrical contractor that provides services through two divisions. The transmission and distribution group provides things like construction and maintenance of high-voltage transmission lines, substations and lower-voltage underground and overhead distribution systems, and storm restoration services to customers in the electric utility and renewable energy industries. The commercial and industrial segment provides design, installation, maintenance and repair services for commercial and industrial wiring. The company also installs traffic networks, bridge, roadway and tunnel lighting. This dividend serves customers like airports, hospitals, data centers, hotels, stadiums, convention centers, manufacturing plants and municipal governments. The long-term returns in capital have been 30% a year over the last decade, so it is a very profitable business. It is cheap right now as the EV/EBIT ratio is just 6.
This year the trailing return on capital has fallen to 23% and an activist investor has taken notice. Engine Capital delivered a letter to the board saying it thinks the intrinsic value of MYR Group is between $29 and $33 per share, which is well above the current price. Engine thinks the board should either sell the company or do a leveraged recapitalization and use the proceeds to pay a special dividend or conduct a tender offer to unlock shareholder value. That would be nice in the short run, but even if it doesn't happen, the company is worth a lot more than the current price and should trade much higher in the years ahead.
Buying high-return companies at low EV/EBIT measures is a little more Fischer-Munger than I usually engage in, but it does beat the market rather handily over the past 15 years. Buying these profitable companies when they have short-term stumbles or during a broad market decline can be a very profitable endeavor.