The earnings season has kick started on a positive note with decent performance across the table. It appears that the equity markets have more or less factored in the risks from the ongoing trade war and is likely to have a relatively smooth spell, buoyed by improving economic sentiments led by solid domestic job market conditions, higher wage rates and lower taxes.
As investors employ a wait-and-see approach in a classic example of “backing and filling” in the market, they could benefit from ‘cash cow’ stocks that garner higher returns.
However, singling out cash-rich stocks alone does not make for a solid investment proposition unless these are backed by attractive efficiency ratios like return on equity (ROE). A high ROE ensures that the company is reinvesting its 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 stocks 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 less 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 15 stocks that qualified the screen:
General Motors Company (GM - Free Report) : Founded in 1908, Detroit, MI-based General Motors is a leading global automotive firm. The company is engaged in designing, building and selling cars, trucks, crossovers and automobile parts worldwide. The company has a trailing four-quarter average positive earnings surprise of 18.4% and long-term earnings growth expectation of 5.5%. General Motors currently carries a Zacks Rank #2.
Microchip Technology Incorporated (MCHP - Free Report) : Incorporated in Delaware in 1989, Microchip develops and manufacturers microcontrollers, memory and analog and interface products for embedded control systems, which are small, low-power computers designed to perform specific tasks. The company has a Zacks Rank #1. Microchip has a trailing four-quarter average positive earnings surprise of 3.9% and long-term earnings growth expectation of 14%.
NRG Energy, Inc. (NRG - Free Report) : NRG Energy is engaged in the production, sale and delivery of energy and energy products and services to residential, industrial and commercial consumers in major competitive power markets in the United States. It has financial and commercial headquarters in Princeton, NJ and operational headquarters in Houston, TX. This Zacks Rank #1 stock has a stellar trailing four-quarter average positive earnings surprise of 507.9%.
AMC Networks Inc. (AMCX - Free Report) : Headquartered in New York, AMC Networks is engaged in producing programming and movie content, and owns and operates various cable televisions. The company has a trailing four-quarter average positive earnings surprise of 28.4% and long-term earnings growth expectation of 6.9%. AMC Networks currently carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Celanese Corporation (CE - Free Report) : Texas-based Celanese is a global hybrid chemical company with diverse products that rank either first or second in their respective markets, based on market share. This Zacks Rank #2 stock has a trailing four-quarter average positive earnings surprise of 7% and long-term earnings growth projection of 8.9%.
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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.
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