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Buy 5 High ROE Stocks as Robust Economy Fuels Rate Hike Fears

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The U.S. equity markets declined in the past few trading sessions as higher-than-expected November ISM data and solid nonfarm payrolls data portrayed signs of a resilient economy that fueled speculations that more interest rate hikes are just around the corner. The Services PMI registered a 56.5 reading in November, indicating an accelerated growth from October’s reading of 54.4. The latest labor market data further showed that payrolls rose by 263,000 in November compared to broad-based expectations of a 200,000 increase. In addition, average hourly earnings improved 0.6% compared with the prior month and 5.1% year over year, as the unemployment rate held steady at 3.7%.

All these economic indicators signified that the overall economy was comparatively better placed for the Fed to continue its aggressive stance against inflation, putting the brakes on a short-term rally witnessed earlier. The markets widely expect that the central bank will likely raise interest rates by a 0.5 percentage point after four successive 75 basis point increases. This, in turn, could put the terminal rate in excess of 5% from its current target range of 3.75-4%.

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. PepsiCo, Inc. (PEP - Free Report) , Ryder System, Inc. (R - Free Report) , AGNC Investment Corp. (AGNC - Free Report) , CNH Industrial N.V. and The AES Corporation (AES - Free Report) are some of the stocks with high ROE to profit from.

Why ROE?

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 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 11 stocks that qualified the screen:

PepsiCo: 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. The company serves customers in more than 200 countries and territories.

The company has a long-term earnings growth expectation of 7.6% and delivered a trailing four-quarter earnings surprise of 4.5%, on average. Pepsi carries a Zacks Rank #2.  You can see the complete list of today’s Zacks #1 Rank stocks here.

Ryder System: Florida-based Ryder System is recognized as one of the world's largest providers of integrated logistics and transportation solutions. It serves a variety of industries, the most significant of which are automotive, electronics, transportation, grocery, lumber and wood products, food service and home furnishing.

The company delivered a trailing four-quarter earnings surprise of 30.1%, on average. Ryder System carries a Zacks Rank #2.

AGNC Investment: Previously known as American Capital Agency Corp., AGNC Investment is a real estate investment trust focused on leveraged investments in Agency residential mortgage-backed securities. That includes residential mortgage pass-through securities and collateralized mortgage obligations.  

AGNC Investment adheres to an active portfolio-management policy, which includes re-evaluation and adjustment of its portfolio and hedges amid a varying interest rate and mortgage market environment. The company delivered a trailing four-quarter earnings surprise of 22.1%, on average. AGNC Investment sports a Zacks Rank #1.

CNH Industrial: Headquartered in London, the United Kingdom, CNH Industrial is one of the leading equipment and services companies engaged in the manufacture and sale of agricultural and construction equipment. Currently, CNH Industrial has a commercial presence in approximately 180 countries.  

The company delivered a trailing four-quarter earnings surprise of 18.9%, on average. CNH Industrial sports a Zacks Rank #1.

AES Corporation: Arlington, VA-based AES Corporation is a global power firm. The company’s businesses are spread across four continents in 14 countries. It uses a range of fuels and technologies to generate electricity, including coal, gas, hydro, wind, solar and biomass, and renewables, such as energy storage and landfill gas.  

AES Corporation has a long-term earnings growth expectation of 8.3% and delivered a trailing four-quarter earnings surprise of 5.6%, on average. It carries a Zacks Rank #2.

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.  

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

Click here to sign up for a free trial to the Research Wizard today.

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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