Identify Companies Creating a Future Sustainable High ROE

Stocks Paying Down Debt and Reducing Share Count

ROE is not one number. It's driven and influenced by a complex set of management's integrated activities. What if you could identify companies turning the right levers creating a future high sustainable ROE? How can we uncover future high ROE ideas before the public assigns a higher valuation.

One approach towards building a discovery process for future favorable ROE, understand the components that drive ROE. Identify bottoms up improvements before a final enhanced ROE is public with a higher valuation. An example of success where the CEO's focus was ROE improvement, Gerstner at IBM. IBM's market capitalization rose from $29 billion to $168 billion when CEO Gerstner focused on increasing ROE. IBM's ROE improvements driven by improving capital structure, capital resources allocated to share buybacks reducing shares outstanding  and positively impacting ROE.

The DuPont equation or strategic profit formula takes a bottom up approach to analyzing ROE. DuPont Corporation used this approach in the 1920s. The equation is broken into 3 parts. This granularity provides transparency to understand and manage the drivers for positive or negative .  The DuPont equation/strategic profit formula enables the analyst to understand the source of superior or inferior actions driving ROE.

Return on equity = PROFITABILITY [profits/sales] x PRODUCTIVITY [sales/assets] x CAPITAL STRUCTURE [assets/equity] = DuPont equation=strategic profit formula.

DuPont Equation explained on Wikipedia. https://en.wikipedia.org/wiki/DuPont_analysis

Management can control or influence ROE by a complex set of integrated activities. For this post I WONT dig into all 3 components and its driving details. All 3 components (productivity, profitability, capital structure) must be proficient, an ineffective link weakens ROE.

This post emphasizes Capital Structure improvements to help find companies improving future ROE. Further, I added more value components to my filtering; share price returns, value oriented institutional ownership, and financial health as an example.

Below are sample ideas and a process description of discoveries for "Mean Reversion Candidates identified by an Improving Capital Structure, Significant Price Decline and…."

Specifically this post takes the last reported 8 financial quarters and looks for companies 1) reducing share count from current quarter to the prior 8th quarter or two year ago quarter. 2) some reducing long term debt during those 8 quarterly periods.

The purpose of this exercise is to find companies quantitatively improving their intrinsic value by reducing shares outstanding and some long term debt.  Further this capital allocation is a vote of future confidence by management to allocate cash to reduce debt and share count. I use the Z score and other measures to ensure a strong financial position. Additional mean reverting metrics include negative stock returns over the prior 2 years period (8 quarters).

I will be adding candidates over the next few days with supporting data to follow. 

North American Energy Partners Inc. (NOA)

North American Energy Partners founded in 1953 and headquartered in Edmonton, Canada. It provides mining and heavy construction services in the resource development and industrial construction sectors.

NOA has been aggressively reducing not only shares outstanding but debt over the past 2 years. The stock is up 30% since the most recent earnings and up 9.50% on Friday (10/09) but still down -57.59% over 52weeks. Tangible book value per share has increased as the price dropped. Tangible book value per share 2012 was $1.92. The MRQ tangible book value is $4.42.

Market Cap: 76.54M, Enterprise Value:  135.22M, price 10/12/15 = $2.36
Price/Sales (ttm):  0.26 , Price/Book (mrq):  0.58
Enterprise Value/Revenue (ttm):  0.44,  Enterprise Value/EBITDA (ttm): 2.91
Revenue (ttm):  305.60M
Qtrly Revenue Growth (yoy): -44.60% , Gross Profit (ttm):  44.38M
EBITDA (ttm):  46.48M
Total Cash (mrq):  31.28M , Total Cash Per Share (mrq):     0.96
Total Debt (mrq):  87.04M , Total Debt/Equity (mrq):      63.80
Operating Cash Flow (ttm):   46.22M , Levered Free Cash Flow (ttm):   16.47M
52-Week Change:    -57.39%
Shares Outstanding:   32.43M , Float:  16.48M
Trailing Annual Dividend Yield:     3.10%

Dillard's Inc. (DDS)

Dillards retails apparel, cosmetic, furniture and consumer goods. In addition, the Company operates a general contracting construction company remodeling their stores. Dillards was founded in 1938.

The company trades at historical and relative valuation discount.  Further, a substantial real estate portfolio is on the books below market value.
Long term debt and shares outstanding have been significantly reduced over the current two year or 8 quarter period.

Shares Outstanding MRQ = 40.10M
Shares Outstanding Qtr Ending 07/13 = 46.33M

Non Current Liabilities MRQ = 1.265B
Non Current Liabilities FY Ending 2011 = 1.456B

Tangible Book Value Per Share  MRQ = $50.25
Tangible Book Value Per Share FY Ending 2011 = $34.79

Market Cap: 3.47B , Enterprise Value : 4.12B
Price/Sales (ttm): 0.52 , Price/Book (mrq): 1.81
Enterprise Value/Revenue (ttm): 0.60 , Enterprise Value/EBITDA (ttm): 5.15
52-Week Change: -13.27%
Shares Outstanding: 34.76M , Float: 18.45M
% Held by Insiders: 10.54% , Short % of Float: 16.67%

Trailing Annual Dividend Yield: 0.30%      

more data and ideas to follow over the next few days...

Alpha Pro Tech Ltd. (APT)
Wireless Telecom Group Inc. (WTT)
SPX Corporation (SPXC)

Companies' aggressively reducing long term debt and share count over the prior past two year period.

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johnheider1 said...

This should be a great series, thanks.

ShadowStock said...

John, not sure if you are serious but I agree …

tracking companies that are reducing share count reducing LTD, financially sound, increasing book value with a declining stock price are limited and worth tracking. Those metrics are ignored but critical to a future higher stock price. Thanks for responding!