Back to top

Image: Bigstock

5 ROE Picks to Buy as High Bond Yields Imply Economic Rebound

Read MoreHide Full Article

The U.S. equity market has been trading near all-time highs in the past couple of days buoyed by relatively healthy economic recovery on better-than-expected jobless claims and uptick in household spending. Federal Reserve Chairman Jerome Powell has further pledged to remain accommodative with its near zero interest rates and monthly bond purchases until the desired unemployment and inflation targets are achieved. However, surging bond yields have suddenly made stock market valuations appear less attractive, leading to broader equity market decline. Notably, the 10-year Treasury yield has hit a high of 1.6%.

As investors employ a wait-and-see approach in a classic example of “backing and filling” in the market, they can benefit from ‘cash cow’ stocks that garner higher returns. However, identifying cash-rich stocks alone does not make for a solid investment proposition unless it is backed by attractive efficiency ratios like return on equity (ROE). A high ROE ensures that the company is reinvesting cash at a high rate of return.

ROE: A Key Metric

ROE = Net Income/Shareholders’ Equity

ROE helps investors distinguish profit-generating companies from profit burners and is useful in determining the financial health of a company. In other words, this financial metric enables investors to identify companies that diligently deploy cash for higher returns.

Moreover, ROE is often used to compare the profitability of a company with other firms in the industry — the higher, the better. It measures how well a company is multiplying its profits without investing new equity capital and portrays management’s efficiency in rewarding shareholders with attractive risk-adjusted returns.

Parameters Used for Screening

In order to shortlist stocks that are cash-rich with high ROE, we have added Cash Flow greater than $1 billion and ROE greater than X-Industry as our primary screening parameters. In addition, we have taken a few other criteria into consideration to arrive at a winning strategy.

Price/Cash Flow lesser than X-Industry: This metric measures how much investors pay for $1 of free cash flow. A lower ratio indicates that investors need to pay less for a better cash flow-generating stock.

Return on Assets (ROA) greater than X-Industry: This metric determines how much profit a company earns for every dollar of asset, which includes cash, accounts receivable, property, equipment, inventory and furniture. The higher the ROA, the better it is for the company.

5-Year EPS Historical Growth greater than X-Industry: This criterion indicates that continued earnings momentum has translated into solid cash strength.   

Zacks Rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform irrespective of the market environment.

Here are five of the 22 stocks that qualified the screen:

CDW Corporation (CDW - Free Report) : Headquartered in Vernon Hills, IL, CDW Corporation is a leading provider of integrated information technology solutions to small, medium and large business, government, education and healthcare customers in the United States, United Kingdom and Canada. This Zacks #2 Ranked company has a long-term earnings growth expectation of 13.1%. The company delivered a trailing four-quarter earnings surprise of 11.1%, on average.

Apple Inc. (AAPL - Free Report) : Headquartered in Cupertino, CA, Apple’s business primarily runs on its flagship iPhone. The company also designs, manufactures and sells iPad, MacBook and HomePod that are powered by software applications, including iOS, macOS, watchOS and tvOS operating systems. The company delivered a trailing four-quarter earnings surprise of 18.5%, on average, and has a long-term earnings growth expectation of 11.5%. Apple currently sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Lam Research Corporation (LRCX - Free Report) : Headquartered in Fremont, CA, Lam Research supplies wafer fabrication equipment and services to the semiconductor industry. This Zacks #2 Ranked company has a long-term earnings growth expectation of 21.3%. The company pulled off a trailing four-quarter earnings surprise of 7.4%, on average.

Polaris Inc. (PII - Free Report) : Headquartered in Medina, MN, Polaris designs, manufactures, and markets power sports vehicles worldwide. It also produces replacement parts and accessories of such vehicles. The company delivered a trailing four-quarter earnings surprise of 25.6%, on average. This Zacks Rank #2 stock has a VGM Score of A.

D.R. Horton, Inc. (DHI - Free Report) : Based in Texas, D.R. Horton is one of the leading national homebuilders, primarily engaged in the construction and sale of single-family houses, both in the entry-level and move-up markets. The company delivered a trailing four-quarter earnings surprise of 25.8%, on average. This Zacks Rank #2 company has a long-term earnings growth expectation of 13.4%.

You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.  

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

Click here to sign up for a free trial to the Research Wizard today.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.