Each month we sort through the thousands of stocks that have a 5-year average return on equity of 10% or more to find our favorite "ROE stocks." We use each company's return on equity, EPS growth, dividend yield and P/E ratio to come up with what we call our Top 100 ROE Stocks List.
The selection criteria are simple: Any US based company with a market capitalization above $1bn is included. Next, we remove all companies that have a 5-year average return on equity of less than 10% and/or negative earnings in the last year. We then pick the 100 companies with the highest return on equity and publish our Top 100 list.
Today we are taking our Top 100 list and highlighting three of our favorite stocks for 2012. Each of these stocks has a 5-year average return on equity over 10%, a long track record of strong EPS growth, a reasonably cheap P/E ratio and a strong dividend yield with a long history of steady dividend growth.
Avon Products (AVP)
Avon Products is going through a management shake-up, and is thus selling at a discount to peers. At a current P/E multiple of just 9.5x, but a long history of strong EPS growth (10.24% per annum since 1991) and a 5-year average return on equity of 45.56%, the stock looks extremely attractive for long-term investors - especially with the current 5.15% dividend yield currently on offer. Our view is that investors would be smart to exploit the temporary headwinds the company faces and enjoy the long-term returns the stock is likely to provide.
Colgate Palmolive (CL)
Despite its relatively high P/E multiple of just above 18x, Colgate is a great investment in our view. It's an example of a great company at a fair price (as compared to a fair company at a cheap price) - we always prefer the former. Colgate has a 5-year average return on equity of 88.55%, a long history of extremely strong EPS growth (over 50% per annum since 1991.) The dividend yield of 2.59% helps iron out some of the price volatility that investors might experience in the short-term. Colgate used to trade at much higher multiples (25x to 40x before the financial crisis) and is continuing to grow strongly, thus we feel that even at an 18x earnings multiple this stock is a strong buy.
Lockheed Martin (LMT)
Lockheed Martin has a 5-year average return on equity of 78.44%, with a history of strong EPS growth (7.8% per annum since 1993), and it also comes with a 4.96% indicated dividend yield. Given its conservatively low P/E multiple of just 10.6x, combined with the prospect that tensions between the US and Iran may rise further in the near future, we believe investors could do worse than buying into a proven winner in the global security industry at a low fundamental valuation.