This Fund Manager Beats the S&P, Shuns Apple and Loves a Certain Metric

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With the stock market continuing to climb a wall of worry, focusing on high quality firms becomes ever more compelling. If and when things head south -- be it our fiscal cliff negotiations or concerns that Europe still doesn't have a solid long-term solution to navigate out of its debt crisis, for example -- the ride will likely be less painful in the big boys with dominant market share with rock solid balance sheets.

Within that context, focusing on firms with strong return on equity, ROE , seems especially timely for today's markets. ROE shows how much a firm is earning on every dollar of equity invested in the company.

The ROE metric is a central focus for the management team of the $4 billion Jensen Quality Growth mutual fund. Over the past 15 years Jensen has rung up an annualized return that is nearly two percentage points better than the S&P 500.

The Jensen managers insist that a company have a 10 year track record of ROE clocking in at 15% or better.

In a recent note to shareholders, the managers explained that they wouldn't even make an exception for Apple ( AAPL ) given that it has just seven years of surpassing that high bar. (Interestingly, the managers note that about 20% of firms that manage to beat their ROE test for seven years end up falling short sometime in the next three. They aren't suggesting Apple will falter. Their message: 10 years is what we know works for us, and we're not going to start bending the rules now.)

The five largest holdings in the portfolio (representing more than 20% of fund assets) are PepsiCo ( PEP ), 3M ( MMM ), Microsoft ( MSFT ), Procter & Gamble ( PG ) and Oracle ( ORCL ).

PEP Return on Equity data by YCharts

An important caveat is that none of those stocks are a recent purchase. Procter & Gamble first made its way into the portfolio in 2000, Oracle is the most recent addition, and that was back in 2009. All five currently have Neutral ratings from YCharts. Still, the fact that they remain in the portfolio and are large positions suggests they still have some mojo.

Sifting through Jensen's recent 13-F filings uncovers more recent additions, albeit, true to Jensen's style, new names tend to be very small positions. In the second quarter, among the new names picked up by Jensen are Altria ( MO ), Portfolio Recovery Associates Inc ( PRAA ), Energizer Holdings ( ENR ), and FLIR Systems ( FLIR ). None have a current "attractive" rating at YCharts, but are well worth checking out.

You can also use YCharts Stock Screener to find companies with a strong ROE and then chart that metric to see how long the stock has been a strong ROE-er. After that step you'll want to check out its current valuation as well. After all, it's the price you pay that matters most.

Using the Screener turned up more than three dozen companies that are rated attractive and have high ROEs. A sampling:

Aflac ( AFL ) meets the ROE test, trades at a sub 10 PE ratio and its current 2.8% dividend yield is part of a steady dividend growth picture.

AFL Return on Equity data by YCharts

Medtronic ( MDT ) has the same story to tell: solid ROE, selling at a below market PE ratio , and for the dividend lovers out there, Medtronic has a nice habit of consistent payout increases.

MDT Return on Equity data by YCharts

You can put together your own ROE-ing team starting with the YCharts Stock Screener .

Carla Fried is an editor for the YCharts Pro Investor Service which includes professional stock charts , stock ratings and portfolio strategies .



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: investing , Stocks

Referenced Stocks: AAPL , AFL , ENR , FLIR , MDT

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