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How ROE Can Ensure Big Gains While Picking Cash-Rich Stocks

In a volatile market, investors mostly prefer ‘cash cow’ stocks, which as the name implies can be easily milked for more cash or profits with little expense involved. These stocks are usually mature companies that require less capital investments and thereby generate more free cash to boost shareholder returns.

However, singling out cash rich stocks alone does not make them a solid investment proposition unless they are backed by attractive efficiency ratios like return on equity (ROE). A high ROE ensures whether a company is reinvesting its cash at a high rate of return.

ROE: The Game Changer?

ROE = Net Income/Shareholders’ Equity

ROE separates the wheat from the chaff and helps investors distinguish between profit-generating companies from profit burners. In other words, this financial metric enables investors to identify those stocks that are not sitting idle on hoards of cash. Instead, it helps spotting companies that deploy cash in such avenues that generate higher investor 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 growing its profits without investing any new equity capital in the business and portrays management efficiency in giving back shareholders more value for their invested money.

The Money-Minting Strategy

In order to shortlist stocks that are cash rich with high ROE, we added Cash Flow greater than $1 billion and ROE greater than X-Industry as our primary screening parameters.

Alas, like all other financial metrics, ROE is not an absolute indicator for short listing stocks in a turbulent market. As such, we have added a few additional criteria to arrive at a winning strategy.  

Price/Cash Flow less than X-Industry:This metric measures how much investors pay for one dollar 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 its assets, which include cash, accounts receivable, property, equipment, inventory and furniture. Of course, the higher the ROA, the better it is.

5 Year EPS Historical Growth greater than X-Industry:This criterion indicates that continued earnings momentum has translated to 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 ten stocks that qualified the screening:

The Travelers Companies, Inc. (TRV)

Gilead Sciences Inc. (GILD)

Lear Corp. (LEA)

CGI Group Inc. (GIB)

Boston Scientific Corporation (BSX)

With an enviable cash pile, these stocks appear enterprising picks when they are blended with other attractive features like high ROE, high ROA and solid historical earnings growth along with a solid Zacks Rank.

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.

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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: http://www.zacks.com/performance.

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LEAR CORPORATN (LEA): Free Stock Analysis Report
 
CGI GRP INC -A (GIB): Free Stock Analysis Report
 
TRAVELERS COS (TRV): Free Stock Analysis Report
 
BOSTON SCIENTIF (BSX): Free Stock Analysis Report
 
GILEAD SCIENCES (GILD): Free Stock Analysis Report
 
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