What are we looking for?
U.S. large caps with high profitability, below-average risk and attractive valuations.
We use the economic performance index (EPI) and relative EPI to help us find stocks with a healthy adjusted profitability. Essentially, we are willing to tolerate a bit less profitability if the risk is lower or if the valuation is attractive. While we may not find the most profitable U.S. companies, we believe they will have other interesting characteristics that totally compensate for the slightly lower profitability.
The screen
We screened U.S. stocks focusing on the following criteria:
- Market capitalization higher than US$10-billion;
- EPI of two or higher – this is the return on capital divided by the cost of capital;
- Relative EPI of 0.6 or higher – this ratio uses the return on capital adjusted for its market capitalization divided by the cost of capital;
- Positive three-month percentage change in the economic value-added (EVA) metric. The EVA gives us a sense of how much value the stock is adding for shareholders and is calculated by taking the net operating profit after tax and subtracting the cost of capital. We want a company with improving fundamentals;
- One-year sales growth higher than 2 per cent – we want a company that manages to grow at least at the rate of inflation.
For informational purposes, we have also included five-year mean return on capital, most recent return on capital, five-year maximum drawdown, price-to-earnings ratio, dividend yield, one-year price return, and recent stock price. The five-year maximum drawdown is the largest percentage decline, from peak to trough, seen over the past five years. Please note that some ratios may be shown as of end of previous quarter.
More about Inovestor
Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added (EVA) approach. With Inovestor, advisers can quickly identify attractive investment opportunities, outsource their stock picking by using model portfolios, and easily communicate investment decisions with clients through client-friendly reports.
What we found
The 10 stocks that met our criteria are shown in the accompanying table, ranked by EPI.
Clorox Co. has the highest EPI of our screen, at 4.5. The cleaning products company saw share price gains – and extraordinary profitability – in the early stages of the pandemic, but the stock has fallen about 20 per cent since the end of July and trades at around the same price as a year ago. Similarly to other well-established U.S. companies such as Johnson & Johnson, Procter & Gamble Co. and Colgate-Palmolive Co., Clorox offers a strong consumer brand that has yielded consistent results in the past that are hard to ignore.
Progressive Corp., one of the biggest auto insurance companies in the U.S., has the second-highest EPI, at 4.4, and the second-highest relative EPI, at 1.2. This latter metric reflects a high return on capital of 38.8 per cent and a reasonable valuation based on its low P/E multiple of 10.2. The five-year maximum drawdown of only 22.3 per cent – the lowest on our list – suggests a resilient company. Moreover, Progressive has the highest three-month EVA change, at 98.2 per cent, and the highest five-year return on capital – 25.3 per cent.
AutoZone Inc., an auto parts retailer and distributor, ranks third on our list, with an EPI of 3.7, and solid profitability with a five-year mean return on capital of 25.1. Automobiles could very well be the next discretionary spending of choice for consumers, for three reasons: First, consumer savings are still well above prepandemic level, suggesting there is room for big purchases. Secondly, some discretionary car maintenance may have been delayed because of teleworking. Finally, the main alternatives for large discretionary spending related to the economy’s reopening, such as air travel, still seem less appealing in the near term.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
For more details about these stocks, subscribe to the Inovestor for Advisors platform for free.
Anthony Ménard is an investment analyst at Inovestor Asset Management.
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