The U.S. equity market has witnessed intense volatility in the past few days as a relatively solid second-quarter performance was negated by apprehensions of a less aggressive Fed pausing the much-anticipated rate cut next week. Investor concerns were aggravated by a dovish monetary policy by the European Central Bank as it left interest rates unchanged with eurozone economy on a downtrend. This further led to speculations that the Fed could also follow suit with rise in durable goods orders fueling rumors of a revision in GDP forecasts.
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 13 stocks that qualified the screen:
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 2.7%. It has a long-term earnings growth projection of 7%.
T. Rowe Price Group, Inc. TROW: Founded in 1937 and headquartered in Baltimore, T. Rowe Price Group is a global investment management firm 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. This Zacks #1 Ranked company delivered a trailing four-quarter average positive earnings surprise of 6%. It has a long-term earnings growth projection of 9.4%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Biogen Inc. BIIB: 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 8.8%. It has a long-term earnings growth projection of 8.4%. Currently, it carries a Zacks Rank #2.
Lockheed Martin Corporation LMT: Headquartered in Bethesda, MD, Lockheed Martin is the largest defense contractor in the world. Its main areas of focus are defense, space, intelligence, homeland security and information technology including cybersecurity. The company has a long-term earnings growth projection of 7%. It delivered a trailing four-quarter average positive earnings surprise of 16%. Currently, it carries a Zacks Rank #2.
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 20.1%. 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.
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Lockheed Martin Corporation (LMT) : Free Stock Analysis Report
Northrop Grumman Corporation (NOC) : Free Stock Analysis Report
Pepsico, Inc. (PEP) : Free Stock Analysis Report
T. Rowe Price Group, Inc. (TROW) : Free Stock Analysis Report
Biogen Inc. (BIIB) : Free Stock Analysis Report
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