After an unexpected rally, leading benchmark indices fell sharply as Fed chairman Jerome Powell issued a grim warning about a prolonged recovery period and stagnant growth due to the coronavirus pandemic. The Fed also raised the pitch for more fiscal stimulus to tide over the crisis. This largely took investors by surprise as most have been pinning hopes on consumer resilience in the domestic market with the economies reopening gradually. Furthermore, this sent a shockwave across markets that until now appeared to have factored in the element of uncertainty regarding the quantum of economic damage from the virus outbreak.
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 its cash at a high rate of return.
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.
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 four stocks that qualified the screen:
Mylan NV (MYL - Free Report) : Based in Hatfield, the U.K., Mylan is a global pharmaceutical firm with a well-established generics business and significant presence in specialty pharmaceuticals. This Zacks #2 Ranked company has a trailing four-quarter positive earnings surprise of 5.5%, on average.
Cadence Design Systems (CDNS - Free Report) : Based in San Jose, CA, Cadence offers software, hardware, services and reusable IC (integrated circuit) design blocks to electronic systems and semiconductor customers. The company has a trailing four-quarter positive earnings surprise of 6.6%, on average. With long-term earnings growth expectations of 11.2%, it carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Progressive Corporation (PGR - Free Report) : Based in Mayfield Village, OH, The Progressive is one of the major auto insurers in the United States. This Zacks #2 Ranked firm has a trailing four-quarter positive earnings surprise of 15.6%, on average. It has a long-term earnings growth projection of 6%.
The Allstate Corporation (ALL - Free Report) : Founded in 1931 and headquartered in Northbrook, IL, Allstate is the third-largest property-casualty insurer and the largest publicly-held personal lines carrier in the United States. This Zacks #2 Ranked firm has a trailing four-quarter positive earnings surprise of 18.5%, on average. It has a long-term earnings growth projection of 7.5%.
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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.
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