The U.S. equity markets, which was experiencing high volatility over the past few days, ended up in the red as investors envisaged no respite from the trade woes in the near term. With some European technology firms joining the bandwagon to impose trade restrictions on Chinese smartphone manufacturer Huawei, the trade landscape appears bleaker. The nine-month old trade war that disrupted supply chains and weighed on the world economy is expected to escalate further as the Trump administration is mulling additional tariffs on $325 billion worth of imports from China.
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 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 17 stocks that qualified the screen:
CDW Corporation CDW: 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 United Kingdom and Canada. This Zacks Rank #2 firm delivered a trailing four-quarter average positive earnings surprise of 8.9%.
Bristol-Myers Squibb Company BMY: New York-based Bristol-Myers Squibb is a global specialty biopharmaceutical firm focused on the development of treatments targeting serious diseases. The company pulled off a trailing four-quarter average positive earnings surprise of 11.9%. It has a long-term earnings growth projection of 5.1%. Currently, it sports a Zacks Rank #1.
Celgene Corporation CELG: Summit, NJ-based Celgene is a biopharmaceutical firm focused on the discovery, development and commercialization of drugs targeting cancer and inflammatory diseases through next-generation solutions in protein homeostasis, immuno-oncology, epigenetic, immunology and neuro-inflammation. The company has a long-term earnings growth expectation of 22.2%, with a trailing four-quarter average positive earnings surprise of 2.6%. Celgene currently carries a Zacks Rank #2.
PepsiCo, Inc. PEP: 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: 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%. Northrop currently carries a Zacks Rank of 2.