MENU

5 Barely Profitable Companies Priced to Sell

Context is critical in the world of investing.  As are expectations.  When we’re evaluating stocks, we must not only understand the underlying business and how it has performed over the years, but also how the market expects that business to perform in the coming years.

One way to quickly analyze the strength of a company is by examining its return on equity (ROE) over time.  Companies that are able to consistently crank out a high ROE are typically very strong.  Think the Canadian banks.

However, a company’s historical ROE does not indicate how the underlying stock is going to perform in the short to medium term.  The market will often times gravitate to historically weak (low ROE) businesses if for some reason the future appears bright.

This will be reflected by the stock’s multiples.  Over the long-term however, should the future resemble the past for these businesses, these multiples will decline.  Therefore, investing in a low ROE business that carries an elevated multiple is typically not a great recipe for long-term investing success.

Put ‘em together

To try and uncover companies that might be trading at elevated, and maybe even expensive valuations, let’s look for consistently low ROEs and high multiples – and specifically when dealing with ROE, price/book multiples.

You see, ROE and the P/B multiple are anchored by the same denominator – shareholder’s equity.  ROE is calculated by dividing net income by equity, and the Price to Book multiple is calculated by dividing current market value by equity.

Taking it one step further, if we divide a company’s ROE by the P/B multiple, with some fancy math (not really), we’re left with net income/market value, which is just a company’s earnings yield (EY).

To illustrate, a company that consistently sports an ROE of 10% and trades at a P/B of 5 (EY = 2%) is potentially far less attractive to an investor, all else being equal, than a 10% ROE and a P/B multiple of 2 (EY=5%).

Get to the stocks

Ok, ok.  The following table consists of 5 companies that currently offer this unappealing combination of consistently low ROE and a relatively high current P/B multiple.

Company Name

5 Yr. Avg ROE

Current P/B

“Earnings Yield”

Canfor (TSX:CFP)

0.4%

2.3

0.2%

Canexus (TSX:CUS)

2.2%

5.3

0.4%

Valeant Pharmaceuticals (TSX:VRX)

3.7%

8.0

0.5%

Agnico-Eagle (TSX:AEM)

1.9%

1.4

1.3%

Progressive Waste Solutions (TSX:BIN)

3.0%

2.1

1.4%

Source:  Capital IQ

Foolish Takeaway

By no means do these metrics capture the entire story for any of these 5 names.  However, this combination does serve as an indication that the market’s expectations for each are misaligned with the historical performance of the respective underlying businesses.  Be mindful of these expectations when considering all 5.

One of the stocks in our special FREE report “5 Canadian Stocks to Replace Your Index Fund” just got taken out at a huge premium.  Click here now to learn about the 4 that are left standing.  It’s FREE!

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool Canada’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.

Follow us on Twitter and Facebook for the latest in Foolish investing.

Fool contributor Iain Butler does not currently own any of the shares mentioned at this time.  The Motley Fool doesn’t own shares in any of the companies mentioned.   

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.