Author: RACHEL FOX
Source
Return on equity is one of the most important criteria for finding growth stocks with superior fundamentals. And top-notch fundamentals are one of the key components within the Investor’s Business Daily investing system.
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Luckily, investors can use MarketSmith chart analysis to seek out stocks that excel in this fundamental measure of profitability.
Return On Equity: A Key Criteria For Top Growth Stocks
What makes return on equity, or ROE, so important is that it serves as a unique measure of profitability. Essentially, return on equity is a reflection of how well a company’s management is handling the business. Think of return on equity as a measure of the dollars in profit vs. equity invested into a company. It is a useful measure to gauge financial execution and select the stocks with a higher potential of long-term success.
To calculate ROE, it’s simply a company’s annual net income divided by shareholders’ equity. Multiply the ratio by 100 to arrive at a percentage figure.
IBD’s method of investing advocates focusing on growth stocks with an ROE of at least 17% or higher. Additionally, IBD uses average shareholder equity over the past two years, not just the most recent year.
You could sift through a company’s earnings to discover its ROE. Or you can use IBD’s proprietary SMR Rating, found in IBD Stock Checkup. SMR stands for sales, margins and return on equity.
In a single letter grade, the rating immediately tells investors how a given growth stock stacks up in those important factors. Investors want to ideally focus on those with an SMR grade of A or B.
Using MarketSmith To Find Stocks With High ROE
Other than earnings and sales, ROE is among the most important criteria for investors to look at before investing in growth stocks. MarketSmith chart analysis is a useful tool for identifying stocks with strong ROE.
Upon screening for stocks with an ROE of 17% or higher in the most recent fiscal year, a stock price of 25 or higher, a Relative Strength Rating of 85 or higher and average daily volume of 500,000 shares or more, MarketSmith returns quite a large list of stocks.
Boosting ROE to 30% or higher shrinks the results and narrows the list down to stocks with stronger EPS Ratings.
Investors using the screen must also go beyond simply seeking out stocks with a high ROE number. Be sure to pay attention to the other fundamental aspects including pretax margin, real sales and strong sales growth, as well as a product or service that leads the marketplace.
This article was originally published July 31, 2020. Please follow Fox at @foxonstocks for more on growth stocks, chart analysis and stock market insight.
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