Updated on 2025/01/02
Investors are always on the hunt for stocks offering the perfect balance of profitability and value. By combining two powerful metrics—Return on Equity (ROE) and Price-to-Earnings (P/E) ratio—this post reveals the top 10 stocks in the S&P 500 that could be worth a closer look.
The screening process draws inspiration from the renowned Magic Formula, focusing on two key steps: ranking stocks with high ROE and separately ranking those with low P/E. The rankings are then combined to generate a final list, highlighting companies that excel in both metrics.
For this analysis, the stock universe is based on the iShares Core S&P 500 ETF (Ticker: IVV), and only companies with positive ROE and P/E ratios are considered. All data, including P/E ratios and company profiles, is sourced from Schwab’s Thinkorswim platform, ensuring accuracy and reliability.
Why High ROE and Low P/E Might Be a Good Combination for Investments
High ROE (Return on Equity) and low P/E (Price-to-Earnings ratio) are two key metrics that can provide valuable insights into a company’s financial health, operational efficiency, and market valuation. Together, they signal the possibility of identifying stocks that combine profitability with value, a desirable mix for investors seeking strong returns.
Understanding High ROE (Return on Equity)
ROE measures a company’s ability to generate profits from its shareholders’ equity.
- What High ROE Indicates:
- Efficient Use of Capital: A high ROE shows that management is effectively using shareholders’ funds to generate earnings.
- Competitive Advantage: Consistently high ROE often indicates a company with strong competitive positioning, such as a well-established brand, cost leadership, or unique product offerings.
- Potential for Growth: Companies with high ROE can reinvest their earnings to grow faster or pay dividends, which are attractive to investors.
- Why It’s Good: High ROE companies are often considered “quality” investments. They tend to be financially sound, capable of navigating market challenges, and are likely to sustain profitability over the long term. These attributes make them attractive for investors who prioritize stability and growth.
Understanding Low P/E (Price-to-Earnings Ratio)
P/E ratio measures how much investors are willing to pay for a dollar of a company’s earnings.
- What Low P/E Indicates:
- Undervaluation: A low P/E ratio may indicate that the stock is undervalued relative to its earnings, providing an opportunity to buy at a discount.
- Market Sentiment: Sometimes, a low P/E reflects pessimistic market expectations, which can be an opportunity if the company’s fundamentals are strong.
- Why It’s Good: A low P/E can allow investors to acquire earnings cheaply, especially if the company’s profitability remains consistent or grows. It increases the potential for price appreciation when the market corrects the valuation.
The Power of the Combination: High ROE + Low P/E
When a company exhibits both high ROE and low P/E, it presents a potentially compelling investment case. Here’s why:
- Profitability at a Discount: High ROE demonstrates that the company is profitable and generates strong returns on equity, while low P/E suggests that the market has not fully priced in this profitability. This mismatch creates an opportunity for value investors to buy into a high-quality company at a discounted price.
- Efficient Earnings Generation: Companies with high ROE use their capital efficiently, making every dollar of equity more productive. When combined with a low P/E, it implies that investors can access these efficient earnings streams at an attractive valuation.
- Potential for Price Appreciation: Over time, the market tends to recognize undervalued stocks, leading to price corrections that reward investors. If the company continues to maintain high ROE, the valuation gap closes, potentially driving significant returns.
Real-Life Applications and Case Studies
Consider this combination with real-world scenarios:
- Case Study: The Market Overlooks Fundamentals A high-ROE company might have a low P/E because the market is focused on temporary setbacks, such as a broader economic downturn or sector-specific issues. If these challenges are short-term, investors buying during this period could see substantial gains as the stock rebounds.
- Case Study: The Hidden Gem Some companies operate in niche markets or less-followed sectors. These companies might deliver high ROE consistently but trade at a low P/E because they’re under the radar. Discovering such stocks can be highly rewarding.
Potential Risks and Caveats
While the combination of high ROE and low P/E is attractive, it’s important to consider potential pitfalls:
- Low P/E Could Signal Underlying Problems:
- A stock with a low P/E might not always be undervalued. Sometimes, it reflects the market’s expectation of declining earnings due to challenges like increased competition, regulatory issues, or declining demand.
- It’s crucial to investigate whether the low P/E reflects actual undervaluation or fundamental issues.
- High ROE Could Be Misleading:
- A company with high ROE might achieve it through excessive leverage rather than operational efficiency. If the company carries significant debt, it could face financial difficulties during adverse economic conditions.
- Sustainable ROE is preferable, supported by organic growth and strong margins.
- Sector and Industry Differences:
- Different industries have varying norms for P/E and ROE. For instance, high-growth tech companies may have high P/E ratios due to expectations of future earnings growth, while low-P/E stocks in mature industries might offer limited upside.
How to Use This Combination Effectively
To maximize the benefits of combining high ROE and low P/E, investors should:
- Assess ROE Sustainability:
- Ensure that the ROE is driven by operational success rather than financial engineering (e.g., debt-fueled growth).
- Look for companies with a track record of consistent ROE over several years.
- Analyze the P/E in Context:
- Compare the P/E ratio to industry averages and historical levels to identify whether the stock is genuinely undervalued.
- Evaluate the company’s growth prospects and ensure the low P/E doesn’t reflect deteriorating fundamentals.
- Conduct a Holistic Analysis:
- Supplement ROE and P/E analysis with other metrics like debt-to-equity ratio, cash flow, and earnings growth.
- Understand the company’s competitive position, management quality, and market dynamics.
- Diversify Investments:
- Avoid over-concentrating in a single high-ROE, low-P/E stock. Diversification across industries and geographies can help mitigate risks.
The Balance of Value and Quality
Investing in companies with high ROE and low P/E is like finding the sweet spot between quality and value. High ROE ensures the company is profitable and efficient, while low P/E offers the potential for growth at a bargain price. However, thorough due diligence is essential to avoid value traps and ensure the combination reflects genuine investment opportunities.
When used effectively, this strategy can serve as a cornerstone for building a robust investment portfolio that delivers long-term, sustainable returns.
Let’s dive into the list and uncover which companies made the cut!
This list will be updated monthly to reflect the latest market changes and valuations, giving you a regularly refreshed look at the best opportunities.
10. KMB – KIMBERLY CLARK
- Current Price/Earnings Ratio: 18,43
- Current ROE: 231,00
9. UAL – UNITED AIRLINES
- Current Price/Earnings Ratio: 6,87
- Current ROE: 27,24
8. HCA – HCA HEALTHCARE INC
- Current Price/Earnings Ratio: 18,21
- Current ROE: 1195,5
7. NCLH – NORWEGIAN CRUISE LIN
- Current Price/Earnings Ratio: 16,40
- Current ROE: 69,78
6. ULTA – ULTA BEAUTY INC
- Current Price/Earnings Ratio: 15,08
- Current ROE: 55,18
5. CHTR – CHARTER COMMUNICATIONS
- Current Price/Earnings Ratio: 10,16
- Current ROE: 32,96
4. FMC – FMC CORP
- Current Price/Earnings Ratio: 5,41
- Current ROE: 38,45
3. DAL – DELTA AIR LINES INC
- Current Price/Earnings Ratio: 7,05
- Current ROE: 40,67
2. JBL – JABIL INC
- Current Price/Earnings Ratio: 7,9,78
- Current ROE: 60,29
1. APA – APA CORP
- Current Price/Earnings Ratio: 3,71
- Current ROE: 61,86
Check this other posts for better understanding about investing and stocks:
How to Analyze Stocks: A Beginner’s Guide
Understanding Stocks and How They Work: The Building Blocks of Investing
Investment Strategies and Styles: Finding the Right Approach for Your Goals
Risk and Return – The Pillars of Every Investment
Building and Managing a Portfolio: Simple Strategies that Work.
How to Identify Undervalued Stocks: A Guide to Smarter Investing
Thank you for exploring the Top 10 “High ROE, Low P/E” Stocks with us! Remember, this list is a starting point for your research, highlighting potential opportunities based on current valuation metrics.
Disclaimer: This is not an investment recommendation. Always conduct your own thorough analysis and consider your financial goals, risk tolerance, and investment horizon before making any decisions. Consult with a financial advisor if needed to ensure your investments align with your overall strategy.
Stay tuned for next month’s update, where we’ll continue to highlight the stocks offering the most attractive valuations!