To weed out some of the best looking company’s in the S&P 500, I started by looking for firms that had an earnings-before-interest-and-tax margin of around 20%, indicating a good flow of cash in to the company’s coffers. Secondly, using historic figures, I whittled down the results to companies that had achieved a five year average return-on-shareholder-equity of greater than 15% to draw out the companies that have consistently delivered a good return on shareholder capital.
Lastly, I searched through analyst predictions and reports to whittle down the remaining candidates, looking for companies that were predicted to improve their gearing ratio by at least 50% over the next three years. For example, a company’s net debt to shareholder equity ratio should fall by 50% over the next three years, indicating improving free cash flows, fiscal prudence, and balance sheet strength.
Note: for the purpose of this piece, gearing is total debt divided by shareholder equity.
The results
Firstly, contract driller Helmerich & Payne, Inc. (NYSE:HP), which has achieved a 13.5% return-on-shareholder equity (ROE), on average per year for the last five years. Part of this strong consistent return is the company’s wide EBIT margin, which for 2012 stood at 28.2%.
| Company | EBIT margin, 2012 | ROE 5-yr average |
|---|---|---|
| Helmerich & Payne | 28.20% | 13.50% |
Helmerich & Payne, Inc. (NYSE:HP)’s EBIT margin is forecast to widen as the company pays down debt and gearing is expected to move into negative territory (net cash balance) this year. Indeed, I can see that in the company’s first-quarter results, gearing had already started to fall, from a level of 3% at the end of last year to 1.5% at the end of the first quarter. The company’s ROE also ticked up slightly based on Q1 annualized data to 14.5% from the 13.5% five-year average.
A chart showing Helmerich & Payne, Inc. (NYSE:HP)’s predicted gearing over the next few years. I have added a logarithmic moving average with a four period prediction to highlight the improving cash position of the company during the next few years.
Next up
Next up is Occidental Petroleum Corporation (NYSE:OXY), which is fast becoming the next major oil conglomerate and is rapidly closing the valuation gap on the world’s third-largest company by revenue, Gazprom. (Gazprom’s currently trading at a record low valuation of two times forward earnings with a market cap of approx. $85 billion. Occidental Petroleum Corporation (NYSE:OXY) is worth $77 billion, trading at 16 times forward earnings.)
| Company | EBIT margin, 2012 | ROE 5-yr average |
|---|---|---|
| Occidental Petroleum | 37.80% | 15.90% |
Occidental Petroleum Corporation (NYSE:OXY) has an EBIT margin of 37.8% and has achieved an average ROE of 15.9% during the past five years. The company does pay about 40% tax however, which impacts its net profit margin, sending it down to around 21%.
Having said that, Occidental Petroleum Corporation (NYSE:OXY) is still forecast to rapidly pay down its debt over the next few years. Once again, I have added a logarithmic moving average with a four period forecast to show how the debt will fall in the future.
