5 ROE Picks As Markets Brace For Earnings Season Volatility

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The U.S. equity markets witnessed intense volatility in the past week with falling oil prices and below-par quarterly performance from leading blue-chip technology stocks weighing on the indices. To add to the woes, the death toll from the coronavirus outbreak continued to mount, forcing President Joe Biden to acknowledge that the country is facing an uphill task to economic recovery as fatalities are likely to increase further over the next few weeks. However, the slump was somewhat pared by solid U.S. manufacturing activity data, which surged to its highest level in more than 13.5 years in early January.  

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 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.

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.

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