The U.S. equity markets seem to have defied the broader economic downturn and hit pre-pandemic record highs buoyed by broad-based growth across almost all sectors. With a better-than-expected performance in the June quarter earnings season from the firms that have reported so far, the markets appear set to ride the growth momentum. However, lack of consensus regarding additional government stimulus to fund the federal aid for millions of Americans affected by the virus outbreak remains a threat for the upsurge. Strained Sino-U.S. ties on diplomatic discord and rising cases of coronavirus were additional headwinds.
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 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 19 stocks that qualified the screen:
Lam Research Corporation LRCX: Headquartered in Fremont, CA, Lam Research supplies wafer fabrication equipment and services to the semiconductor industry. This Zacks #1 Ranked company has a long-term earnings growth expectation of 15.4%. The company has a trailing four-quarter earnings surprise of 6%, on average.
Best Buy Co., Inc. BBY: Incorporated in 1966 and headquartered in Richfield, MN, Best Buy is a multinational specialty retailer of consumer electronics, home office products, entertainment software, communication, food preparation, wellness, heath, security, appliances and related services. The company has a trailing four-quarter earnings surprise of 21.6%, on average. The Zacks Rank #2 company has a long-term earnings growth expectation of 8.2%.
T. Rowe Price Group, Inc. TROW: Founded in 1937 and headquartered in Baltimore, T. Rowe is a global investment management organization that provides a broad array of mutual funds, sub-advisory services and separate account management for individual and institutional investors, retirement plans and financial intermediaries. The company has a trailing four-quarter earnings surprise of 6.3%, on average. It has a long-term earnings growth projection of 7.8%. T. Rowe has a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Cadence Design Systems, Inc. CDNS: Based in San Jose, CA, Cadence Design offers software, hardware, services and reusable IC design blocks to electronic systems and semiconductor customers. This Zacks #2 Ranked firm has a trailing four-quarter earnings surprise of 11.5%, on average. It has a long-term earnings growth projection of 13.7%.
KLA Corporation KLAC: San Jose, CA-based KLA Corporation is an original equipment manufacturer of process diagnostics and control equipment and yield management solutions required for the fabrication of semiconductor integrated circuits or chips. The company has a trailing four-quarter earnings surprise of 9.6%, on average. This Zacks Rank #2 company has a long-term earnings growth expectation of 10.3%.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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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.