Barron’s 400 Index companies earn stellar returns, compared to the 6,000 they are selected from.
The kinds of returns we mean are not just profits, but profits in relation to the companies’ assets, equity capital and total investment capital. Returns on assets (ROA), equity (ROE) and investment (ROI) rank high among the metrics that investors and analysts consult when evaluating and comparing companies.
To compute ROA, the trailing 12-month net income is divided by total assets (liabilities plus shareholders’ equity) for the most recently reported period. ROE is trailing 12-month net income dividend by total shareholders’ equity. ROI is trailing 12-month operating income divided by total invested capital.
These three are usually viewed together because each presents just part of the return picture, which varies by industry and by company. For example, ROE can be inflated for a company that borrows a lot of its capital, for which ROA and ROI restore perspective. ROA is affected by whether the assets remain bolted in place or walk out the door each evening.
Here is how the Barron’s 400 companies compare with the “universe”:
The contrast couldn’t be starker. The medians for the Barron’s 400 companies are three to nine times higher than for the universe. Those negative averages for the universe are testimony to how slow and ragged the economic recovery has been—as well as how skillfully the Barron’s 400 companies have negotiated those challenges. Don’t fail to notice, by comparing the means with the medians, that the Barron’s 400 companies tilt higher while the universe tilts lower.
Such are the basic data. They are just three of the two dozen that MarketGrader tracks in assessing companies for the Barron’s 400. They are important indicators but not the last word in security analysis. When you dig down into specific circumstances you find that investing can be anything but straightforward.
Terra Nitrogen Co., a limited partnership that manufactures and distributes nitrogen fertilizer products, has the highest ROA in the Barron’s 400—88%. Terra Nitrogen does well in this measure because it has no debt and minimal other liabilities. The lack of debt also means the company ranks high in ROE (132%) and ROI (which at 233% also is the highest in the Barron’s 400), based on shareholder equity of $253.8 million at the end of the third quarter.
These ratios show that Terra Nitrogen does a very effective job of transforming invested capital into a stream of profits. As good as that is, however, it is not the whole story. Terra Nitrogen’s sales and earnings have been under pressure because of falling prices for its product, which is made in part from increasingly plentiful natural gas. As a result, its stock price has dropped 47% from a high this year of $254 to $135 a share recently.
The moral of Terra Nitrogen’s current story is that while financial strength can enable a company to weather adverse market forces, it can’t trump them.
By contrast, Entravision Communications Corp. has the lowest ROA (minus 2%) and ROE (minus 171%) in the Barron’s 400. The diversified Spanish-language media company has lots of debt ($371 million in the third quarter) and total liabilities ($461 million). Its shareholder equity has sunk to a deficit of $5.6 million at the end of the third quarter from a positive $5.4 million a year earlier.
Moreover, revenue and profit are being hurt by a sharp fall-off in political advertising from 2012. And yet Entravision’s stock jumped 237% this year from $1.66 to $5.59 a share recently, and had climbed as high as $7.20.
So financial strength, while clearly a good thing, is not all that Mr. Market looks at when deciding which stocks to favor. It sure helps to be in the right place at the right time, which seems to be where Entravision is with this country’s growing Spanish-speaking population.
Nonetheless, ROA, ROE and ROI provide invaluable insight into how well a company is running its business. That these returns are collectively so high for the Barron’s 400 companies validates the selection process for this growth-focused index.