What are we looking for?
Today we look at companies trading in the United States with the biggest return on equity, after screening Toronto-listed firms on Thursday. ROE offers evidence of how well management is using shareholders' equity to make money. It's often a useful tool for rating competitors as well as being a good starting point in the quest for efficient, well-run businesses.
The Screen
We took companies with a market value of at least $1-billion (U.S.) and let Bloomberg scour the ranks for any player with a return on equity of more than 20 per cent. The calculation is made by dividing profit by shareholders' equity. Bloomberg defines profit as net income minus preferred dividends. It defines shareholders' equity as share capital plus additional paid-in capital plus retained earnings. And it combines figures for the most recently completed quarter plus estimates for the current quarter.
What did we find?
The search generated far more results than Thursday's scan of Canadian listings, even after raising the bar on ROE levels. Listed here are the 20 companies showing the highest ROE along with a long enough track record to produce a five-year average ROE.
ROE is only a starting point for investors to compare a firm's competitiveness. Numerous factors can distort the number, so it's important to look at the five-year average, as well as for a consistently rising trend.
Any event that reduces shareholder equity can give an artificial boost to ROE. These may include a writedown of assets, a buyback of shares or the assumption of more debt. It's important to use ROE in conjunction with other measurements, such as return on invested capital, for example, which provides a clearer picture of how much of the returns are being fuelled by debt.
The top performers on today's chart all took writedowns in the last year as they adjusted their businesses to deal with the recession and the weak recovery. That had the effect of reducing shareholder equity and making their ROE higher after one-time charges to income were booked.
Sara Lee booked a charge of $207-million last year after selling some operations. Starbucks incurred a hefty charge after announcing a plan last year to close 900 stores. Estée Lauder also had a recent restructuring charge. Tempur-Pedic International Inc., meanwhile, has spent several hundred million dollars this year buying back its own shares.