The U.S. equity market seems to have hit a pause as it awaits the resolution of the prolonged trade war on the resumption of bilateral trade talks between President Trump and his Chinese counterpart on the sidelines of G20 summit. As tensions in the Middle East refuse to die down with a latent threat of an escalation of an armed conflict with Iran, a favorable outcome in Sino-U.S. relationship will likely have a cascading effect on the market.
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, 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 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 12 stocks that qualified the screen:
CDW Corporation (CDW - Free Report) : Headquartered in Vernon Hills, IL, CDW is a leading provider of integrated information technology solutions to small, medium and large business, government, education and healthcare customers in the United States, the U.K. and Canada. This Zacks Rank #2 firm delivered a trailing four-quarter average positive earnings surprise of 8.9%.
Biogen Inc. (BIIB - Free Report) : Based in Cambridge, MA, Biogen is one of the world’s leading biotechnology companies, which focuses on developing innovative therapies for treating serious neurological and neurodegenerative diseases. The company pulled off a trailing four-quarter average positive earnings surprise of 6.4%. It has a long-term earnings growth projection of 8.4%. Currently, it carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Applied Materials, Inc. (AMAT - Free Report) : Founded in 1967 and headquartered in Santa Clara, CA, Applied Materials is one of the world’s largest suppliers of equipment for the fabrication of semiconductor, flat panel liquid crystal displays and solar photovoltaic cells and modules. The company has a long-term earnings growth expectation of 9%, with a trailing four-quarter average positive earnings surprise of 3.3%. Applied Materials currently carries a Zacks Rank #2.
PepsiCo, Inc. (PEP - Free Report) : Headquartered in Purchase, NY, PepsiCo is one of the leading global food and beverage companies. Its complementary brands/businesses include Frito-Lay snacks, Pepsi-Cola beverages, Gatorade sports drinks, Tropicana juices and Quaker foods. This Zacks #2 Ranked company delivered a trailing four-quarter average positive earnings surprise of 3.5%. It has a long-term earnings growth projection of 7%.
Northrop Grumman Corporation (NOC - Free Report) : Based in Falls Church, VA, Northrop supplies a broad array of products and services to the U.S. Department of Defense, including electronic systems, information technology, aircraft, space technology and systems integration services. It came up with a trailing four-quarter average positive earnings surprise of 18.5%. The company has a long-term earnings growth expectation of 12.8%. At present, Northrop holds a Zacks Rank of 2.
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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.