Editor's Note: This article was originally published at 3 p.m. EDT on Real Money on June 23. Sign up for a free trial of Real Money.
When I was researching yesterday's column about stocks with high returns on capital, I ran across a video of noted value investor Joel Greenblatt talking about how he uses this measure to select stocks. He mentioned that most of the stocks in his portfolio had a return on capital of 50% or more.
Now, that's a huge number and it reminds me that John Danaher, of private equity firm Leonard Green, said earlier this year that he confined his purchases to those companies that were growing earnings before interest, taxes, depreciation and amortization (EBITDA) at 50% a year or more. Companies that can earn those types of returns and growth should be compounding miracles for investors who buy them at the right prices.
The key is the right price. Greenblatt also said that the way to earn high returns is to find these superior companies and buy them when the market is giving them away for some reason. He prefers the metric of earnings yield but I suspect you can also use price to book and Enterprise Value (EV) to EBITDA.
Very few stocks are really cheap right now so most of the names I uncovered using a return of capital a screen are not going into my portfolio today. They are going to the very top of my watch list as stocks to buy in broad-market or sector declines. If one of these great companies stumbles and misses earnings or has some other one-off event that makes their stocks cheap enough to buy, I will be ready to pounce.