After a tumultuous start to the month that sent global markets into a tailspin, two key inflation reports have helped to stabilize the situation. The broader equity markets are inching closer to the all-time highs reached in mid-July, signaling a potential return to normalcy. While the producer price index (PPI), which measures wholesale prices, rose by a slight 0.1% last month, the consumer price index (CPI), a broader measure of prices for goods and services, increased by 0.2%. This resulted in a 12-month inflation rate of 2.9%, marking the lowest level since March 2021. This data has provided much-needed direction for a market that has been volatile in recent weeks. It also highlights the resilience of the U.S. economy, leading to increased optimism about a potential interest rate cut by the Federal Reserve next month. This has fueled an upward trend in the stock market. With a better-than-expected 2.8% annualized GDP growth in the second quarter and strong labor market conditions, the U.S. economy appears to be back on track, easing recessionary fears. In this environment, investors are adopting a wait-and-see approach, opting for a cautious strategy known as “backing and filling” in the market. This strategy involves buying and selling stocks gradually to manage risk and maximize potential returns. A key element of this approach is identifying “cash cow” stocks – companies that generate significant cash flow. However, simply identifying cash-rich stocks is not enough to guarantee a solid investment proposition. Investors must also consider attractive efficiency ratios like return on equity (ROE). A high ROE indicates that the company is effectively reinvesting cash to generate high returns. Five stocks that stand out with both high ROE and robust cash flow include:
Upbound Group (UPBD):
This Plano, TX-based company is a leading lease-to-own provider operating in the United States, Puerto Rico, and Mexico. Upbound Group offers a flexible lease purchase agreement, enabling consumers to access and obtain ownership of high-quality durable products without incurring long-term debt obligations. The company has a trailing four-quarter earnings surprise of 3.8% on average and a VGM Score of B. It carries a Zacks Rank #2.The AES Corporation (AES):
AES is a global power company headquartered in Arlington, VA, with operations across four continents in 14 countries. The company has four Strategic Business Units located in the U.S. and other regions worldwide. AES is a leader in the utility industry’s transition to clean energy, investing in sustainable growth and innovative solutions while delivering superior results. It has a trailing four-quarter earnings surprise of 19.2% on average and carries a Zacks Rank #2.Arch Capital Group Ltd. (ACGL):
Headquartered in Pembroke, Bermuda, Arch Capital provides insurance, reinsurance, and mortgage insurance globally. The company offers a wide range of products and services, including primary and excess casualty coverages, professional indemnity, workers’ compensation, and umbrella liability and employers’ liability insurance. Arch Capital has a long-term earnings growth expectation of 6.1%, a trailing four-quarter earnings surprise of 28.9% on average, and a VGM Score of B. It carries a Zacks Rank #2.PulteGroup, Inc. (PHM):
Based in Atlanta, GA, PulteGroup engages in homebuilding and financial services, primarily in the United States. The company operates through two primary business segments: Homebuilding and Financial Services. PulteGroup maintains a 50/50 balance between build-to-order and spec sales, ensuring it meets immediate demand with spec homes while also accommodating buyers seeking customized homes. The company has a long-term earnings growth expectation of 19%, a trailing four-quarter earnings surprise of 10% on average, and a VGM Score of B. It carries a Zacks Rank #2.Banco de Chile (BCH):
This Santiago, Chile-based company provides a wide range of banking services to customers in Latin America. These services include deposit accounts, loans, payment-related cards, insurance solutions, cash management, treasury, financial advisory, trade finance, leasing, factoring, payment, payroll, collection, mutual fund management, securities brokerage, currency trading, investment management, collection, securitization, and capital markets services. The company has a trailing four-quarter earnings surprise of 6.1% on average and carries a Zacks Rank #2.ROE: A Key Metric
ROE, calculated as Net Income divided by Shareholders’ Equity, is a crucial financial metric that helps investors differentiate profit-generating companies from those that struggle to generate profits. It also provides insights into a company’s financial health. ROE enables investors to identify companies that strategically deploy cash to maximize returns. Moreover, ROE is frequently used to compare the profitability of one company against others within the same industry. A higher ROE generally indicates better performance. It measures how effectively a company multiplies profits without investing additional equity capital, reflecting management’s ability to reward shareholders with attractive risk-adjusted returns.
Screening Parameters
To identify cash-rich stocks with high ROE, specific screening parameters are used:
*
Cash Flow greater than $1 billion:
This ensures the company generates substantial cash flow.*
ROE greater than X-Industry:
This indicates that the company’s ROE exceeds the average ROE for its industry.In addition to these primary screening parameters, other criteria are considered to refine the selection process:
*
Price/Cash Flow lesser than X-Industry:
This metric determines how much investors pay for $1 of free cash flow. A lower ratio suggests investors pay less for a stock that generates higher cash flow.*
Return on Assets (ROA) greater than X-Industry:
ROA measures how much profit a company earns for every dollar of asset (including cash, receivables, property, equipment, inventory, and furniture). A higher ROA indicates better performance.*
5-Year EPS Historical Growth greater than X-Industry:
This criterion highlights companies with consistent earnings momentum that translates into strong cash strength.*
Zacks Rank less than or equal to 2:
Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks consistently outperform regardless of the market environment.These parameters help to narrow down the search for cash-rich stocks with high ROE, providing investors with a solid foundation for making informed investment decisions. By focusing on companies with both strong financial performance and robust cash flow, investors can navigate market volatility and position themselves for potential growth and returns.
