Stock picking is an art and a science. The art of stock picking
relies on the skill to choose the right stock at the right time.
It's possible to do this in a more consistent manner through
thetechnical analysis of a stock chart. The science in stock
picking is in analyzing the fundamental picture of a company in an
effort to forecast future performance. The good balance between art
and science breeds the most successfulinvestments .
One easy-to-use and underutilized metric for making
wiseinvestment decisions is return onequity (ROE). This
metric can tell investors whether a company is acash creator or a
cash destroyer relative to its competitors. The ROE measures a
company's profitability by determining how muchprofit is being
generated from the money invested by shareholders. So knowing this
figure enables investors to comparemultiple stocks and isolate the
most profitable companies of an industry.
In its most simple form, the ROE is determined by dividing a
company's annualearnings by the average shareholder equity, also
known asbook value (ROE = annual earnings/shareholder equity).
There are several financial websites where you can easily find
And when investors can find companies that have a high ROE and
low debt, then they've got a great investment opportunity
Here are two stocks with a high ROE and low debt that are strong
candidates as profitable portfolio holdings.
1. Telecom Argentina (
An ROE close to 33% and a very smalldebt load (133 million
Argentinian pesos in debt vs. 2 billion Argentinian pesos in cash)
make this stock very appealing. In fact, thedebt-to-equity
ratio has been dropping this year and is now at 0.02, compared to
industry stalwarts such as
which sport debt-to-equity ratios of 0.63 and 0.57
respectively. The fact that this leading Argentinean telecom
offers a 9%dividend yield and has registered a 37% earnings growth
in the past five years, makes this a true income-generating
Despite these good figures,shares were hammered down by nearly
24% between August and November. The problem wasn't really the
stock, but the country -- Argentina. Investors are fearful the
companywill be nationalized by the Argentinean government, which is
teetering on a debt default.
As you can see from the chart below, the share price has bounced
from the November lows, hitting resistance at $11. Thisprice action
sets up a classic breakout trade. Buy the stock on the first daily
close above $11, with this number becoming the initial stop level.
My target price on this stock is $24 sometime during the next 18
months, barring any aggressive government intervention.
2. Ross Stores (Nasdaq: ROST)
This discount retailer's ROE of nearly 47% makes it better than 92%
of its competitors in the apparel industry. The company reported
better-than-expected same-store sales in November, with a 2% gain
compared with the previous month. Total sales ramped up 6% for the
month of November 2012 to $813 million compared to $765 million in
With the holiday season upon us, management has projected
monthly same-store sales to increase 2-3% in December and 1-2% in
January. Ross Stores has boosted steady gross profits by 27%
andoperating income by 11% since 2009. In addition, its
price-to-earnings-ratio (P/E ) of 16.7 compared with the sector
average of 18 paints a compelling picture for additional growth. In
2011, revenue pushed above $8 billion, making this discount
retailer a true player in the sector.
After posting a strong uptrend in 2012, shares have been selling
off since August. Plunging nearly 20 points to just above $50 has
set up a technical value "buy" opportunity. Buying in the channel
between $51 and $55 with a stop at $49 makes sense right now. I
would not be surprised to see this stock return to near $70 within
the next 12 months.
Risks to Consider:
While the ROE can be a powerful stock-screening tool, it
shouldn't be used by itself. There are factors such as share
buybacks and increasing corporate debt that can result in a high
ROE, yet poor stock performance. So don't invest based solely on a
strong ROE number without taking the entire company's picture into
Action to Take -->
I like the technical and fundamental picture of both companies
right now. I think Argentina will work out its debtissues without
additional meddling in Telecom Argentina, although anything can
happen. Ross Stores' improving metrics should only get better as
consumers feel more confident to spend this holiday season. If you
apply the science of stock picking and the art of chart reading,
then Telecom Argentina as a breakout trade and Ross Stores as a
pullback value investment make sense.