“Return on Equity – Part of a Winning Srceening Strategy”

Screen of the Week: This week, Kevin Matras goes over the popular ROE2 strategy. See what items go into this winning screen and get 3 of its newest picks.

This screen uses the ‘Return on Equity’ measure (or ROE) as one of the main components layered on top of the Zacks Rank.

The ROE item is one of the quickest ways to gauge whether a company is creating assets or gobbling up investors’ cash.

Very simply: Return on Equity = income / common equity

For instance; if the ROE is 10%, then ten cents of assets are created for each $1 in shareholder equity.

This ratio is always expressed as a % and the higher the number, the better.

Knowing the company is generating assets on invested capital (which includes reinvested earnings) rather than burning thru is good to know.


  • Zacks Rank = 1
    (We start by narrowing down the Universe to just the Zacks #1’s.)
  • ROE >= 10
    (Then we’re going to apply the Return on Equity. The median ROE value for all of the stocks in the Zacks Universe is right around 10. So any company under this benchmark is disqualified.)
  • Price/Sales <= 1
    (A low price to sales ratio (1 and below for example), is usually thought to be of better value, since the investor is paying less for each unit of sales.

    Simply put, the Price to Sales ratio (Price divided by Sales) tells you how much you’re paying for each dollar of sales the company makes. And paying less than a dollar, for a dollar’s worth of something, is a good value.
  • Price >= 5
    (For good measure, only stocks trading at a minimum of $5 or higher. Since most money managers won’t touch anything under $5, we’ll make sure our picks are on their radar screen.)
  • % (Broker) Rating Strong Buy = Top# 5
    (The % of Broker Ratings that are a Strong Buy and we’re looking for the Top 5 stocks.)

    First, since broker ratings are typically skewed towards the ‘buy’ side, we’re going to cancel out any company where the brokers aren’t fully on board.

    And the Top# 5 means we’re going to limit the screen to only the top 5 companies that meet all of the above criteria that have the highest % of brokers rating the stock a Strong Buy.

The Results

Over the last 6 years, this strategy has shown an average Annual Compounded Growth Rate of 53.9% a year, with an average win ratio (winning periods divided by the total number of periods) of 72%. And it always only produces 5 stocks for your portfolio each month.

To break it down further:

In 2001, the average Compounded Annual Growth Rate was 65.3%, with an average win ratio of 71%.

In 2002, the average Compounded Annual Growth Rate was 50%, with an average win ratio of 65%.

In 2003, the average Compounded Annual Growth Rate was 109.9%, with an 87% win ratio.

In 2004, the Compounded Annual Growth Rate averaged 32% with a win ratio of 67%.

In 2005, it was 80.6% with a win ratio of 62%.

And in 2006, the avg. Compounded Annual Growth Rate was 8.9% with a win ratio of 63%.

For further illustration, I ran a continuous backtest over the last 6 yrs. starting on 1/5/01 and going thru 12/31/06, rebalancing the portfolio every four weeks, and compounding the returns each period to greater simulate how one would invest.

During that period, this strategy increased by over 1,325%. In contrast, the S&P 500 only gained 19%.

Here’s 3 stocks from that screen for 5/15/07:

CE Celanese Corp.
JAH Jarden Corp.
WHR Whirlpool Corp.

Get the rest of the stocks on this list and start using this strategy in your own trading. Or use the Research Wizard program to create your own winning screens. You can do it. Sign up now for your free trial to the Research Wizard and start finding better stocks today.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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