Rules of the Game: Hidden ROE Gems

 | Jan 28, 2013 | 1:00 PM EST  | Comments
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One of the fundamental metrics I've relied on for years is return on equity. This ratio -- calculated by dividing shareholder equity into net income -- indicates how much profit a company creates with money that's been invested.

Return on equity, along with growth in cash flow per share, profit margins, and sales and earnings, can be a predictor of share price appreciation. It's also a good way of comparing profitability of companies within the same industry subsector.

Over the weekend, I screened for large-caps with ROE of greater than 15% in each of the past five years. Plenty of the usual suspects turned up: ExxonMobil (XOM), Apple (AAPL), Google (GOOG), Microsoft (MSFT), IBM (IBM), Wal-Mart (WMT) and Procter & Gamble (PG).

But I wanted to drill down to some of the large-caps that don't get so much attention, yet may have good potential.

Southern Copper (SCCO) sports an ROE of 36% in the trailing 12 months. The Phoenix-based company, which operates mining operations in Peru, Mexico and Chile, has a market cap of nearly $35 billion. It trades 1.8 million shares per day.

Copper prices have soared in recent years, helping to send the stock higher.

Investors apparently expect those copper pricing trends to continue, spurred by demand from emerging markets, including China. The stock is up 9% so far in January, having closed Friday at $41.25, a 52-week high. The rally remains intact, despite a threat from Peruvian miners to go on strike if they can't reach a wage deal with the company.

Southern Copper's stock is extended right now, 8.8% above its 50-day average and 28.1% above its 200-day. This is its ninth month in a row with gains, so a pullback would not be out of the question in the near future.

Dividends have increased in the past two years and Southern Copper has a dividend yield of 9%.

There's clearly reason to keep tracking the technicals on this stock and look for opportunities to enter on a pullback with moving average support.

Another, mostly-unheralded large-cap with a strong history of return on equity is Praxair (PX). The company sells specialty gases and coatings used in a variety of industrial applications. Its trailing 12-month ROE is 30%.

Praxair has a market cap of about $33 billion. It moves more than 1 million shares per day.

The stock has been consolidating, but is within striking distance of its April high of $116.93. It closed Friday at $111.73, 2.3% above its 50-day line and 3.4% above its 200-day. It is perched below its shorter-term 5-day and 15-day exponential averages.

The stock skidded 2.9% Wednesday, after reporting in-line fourth-quarter results. But it rallied in subsequent sessions, ending the week with a loss of 1.6%.

Though Praxair's sales and earnings growth have stumbled lately, analysts see 2013 income of $6.10 per share, a year-over-year gain of 10%. Earnings are expected to grow another 13% in 2014, to $6.87 per share.

Praxair's dividend grew in each of the past nine years. Its dividend yield is 2.1%.

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