What are we looking for?
Stocks with strong profits at a reasonable price.
As bond yields tick upward, fixed-income securities are providing more competition for equities, and stocks are wavering. So, it's an opportune moment to search for U.S. companies with muscular earnings that are available for sale cheap. These stocks would seem well positioned to withstand economic gales.
How we did it
Craig McGee, senior consultant at CPMS Morningstar Canada, filtered the CPMS U.S. database for the top 20 stocks with the highest returns on equity (ROE) and highest earnings yields compared with their own histories. He looked for firms that had:
-a market cap greater than $500-million (U.S.);
-an estimated ROE greater than the firm's median ROE over the past 10 years;
-an estimated earnings yield (earnings per share divided by share price) greater than the company's median earnings yield over the past decade;
-a positive change in analysts' consensus earnings estimates over the previous three months;
-an estimated ROE less than 200 per cent (to remove extreme values that might be based on one-time factors that won't be repeated).
To ensure adequate diversification, Mr. McGee allowed no more than three stocks from any single sector.
More about Morningstar
Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its investment research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market.
What we found
The 20 companies listed here are producing good returns on equity compared with their own past performance; they're also available at valuations that are cheaper than their own historical standard. That's an intriguing combination that suggests profits may lie ahead if valuations rise to reflect those earnings.
Remember, though, that this combination could also signal the market's skepticism about how long each company's strong returns will last. Do your own research before buying any of the names listed here.