The broader equity markets stumbled midweek after a relatively healthy start as oil prices surged following repeated attacks by Iran and the Tehran-backed Houthi militant group and retaliation by the United States. With the safe passage for commercial vessels in the Strait of Hormuz becoming a thing of the distant past, Brent crude prices soared beyond $100. As the U.S. President threatened to launch a “massive attack” against Iran, investors remained jittery, with the stock market bearing the brunt.
The renewed hostilities in the Middle East prompted investors to reassess the geopolitical risks and embrace the idea of market volatility as the new normal, as a lasting U.S.-Iran agreement appears to be far from guaranteed. 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, such as return on equity (ROE). A high ROE ensures that the company is reinvesting cash at a high rate of return. Ross Stores, Inc. ROST, Arista Networks, Inc. ANET, Broadcom Inc. AVGO, Host Hotels & Resorts, Inc. HST and AMETEK, Inc. AME are some of the stocks with high ROE to profit from.
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.
Screening Parameters
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 assets, 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 14 stocks that qualified the screening:
Ross: Based in Dublin, CA, Ross is an off-price retailer of apparel and home accessories, offering in-season, branded and designer apparel, footwear, accessories and other home-related merchandise. Operating primarily in the United States, it targets middle-income households, keeping prices at generally 20% to 60% below the regular prices of most department and specialty stores.
The company has a long-term earnings growth expectation of 11.5% and delivered a trailing four-quarter earnings surprise of 10.2%, on average. Ross carries a Zacks Rank #2 at present. You can see the complete list of today’s Zacks #1 Rank stocks here.
Arista: Santa Clara, CA-based Arista is engaged in providing cloud networking solutions for data centers and cloud computing environments. The company holds a leadership position in 100-gigabit Ethernet switching for the high-speed datacenter segment. It is increasingly gaining market traction in 200- and 400-gig high-performance switching products and remains well-positioned for healthy growth in the data-driven cloud networking business with proactive platforms and predictive operations.
The company has a long-term earnings growth expectation of 19.9%. It delivered a trailing four-quarter earnings surprise of 8.3%, on average. Arista carries a Zacks Rank #2.
Broadcom: Headquartered in San Jose, CA, Broadcom develops a broad range of semiconductor solutions for enterprise and data center networking, home connectivity, set-top boxes, broadband access, telecommunication equipment, smartphones and base stations, data center servers and storage systems, factory automation, power generation and alternative energy systems, and electronic displays.
The company has a long-term earnings growth expectation of 51.2%. It delivered a trailing four-quarter earnings surprise of 2.2%, on average. Broadcom currently carries a Zacks Rank #2.
Host Hotels: Bethesda, MD-based Host Hotels, one of the leading lodging real estate investment trusts (REITs), engages in the ownership, acquisition and redevelopment of luxury and upper-upscale hotels in the United States and abroad. Its properties are positioned mainly in growing markets in the United States and globally and include premium brands, such as Marriott, Westin, Ritz-Carlton, Hyatt, Sheraton, W, St. Regis, The Luxury Collection, Fairmont, Four Seasons, Swissôtel, ibis, 1 Hotels, Novotel and Hilton.
Host Hotels delivered a trailing four-quarter earnings surprise of 8.7%, on average. Host Hotels carries a Zacks Rank #2.
AMETEK: Located in Berwyn, PA, AMETEK is one of the leading manufacturers of electronic appliances and electromechanical devices. It has more than 120 operating sites worldwide. The company operates more than 80 sales and service stations in North America, Europe, Asia and South America to support these operations.
The company has a long-term earnings growth expectation of 8.8%. It delivered a trailing four-quarter earnings surprise of 5.2%, on average. AMETEK carries a Zacks Rank #2.
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Host Hotels & Resorts, Inc. (HST): Free Stock Analysis Report
Ross Stores, Inc. (ROST): Free Stock Analysis Report
AMETEK, Inc. (AME): Free Stock Analysis Report
Broadcom Inc. (AVGO): Free Stock Analysis Report
Arista Networks, Inc. (ANET): Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).