When the stock market becomes uncertain, investors often tend to flock toward defensive stocks or stocks that have very high-quality earnings. That generally means that their dividends are deemed safe as well. It turns out that Merrill Lynch’s February RIC report has a focus on high-quality stocks to outperform low quality because they tend to outperform in volatile markets.
The RIC report featured a screen for companies with a high return on equity (ROE). Merrill Lynch’s Matthew Trapp and Savita Subramanian believe that volatility will remain. After all, a slowing growth story is being doubled by uncertainty about Federal Reserve rate increases and commodity price weakness. They also pointed out that high-quality stocks also have more attractive valuations for being cash-rich large cap stocks with dividend growth potential.
February’s RIC report does admit that recession risks are rising in the quantitative analysis but are so far contained. Late-cycle excesses that would be typical warning signals of an impending downturn are not present, and growth elsewhere has remained robust despite weakening industrial sector data.
Subramanian’s preferred measure of quality is low earnings dispersion. These have lower earnings risk and high returns on equity. She screened for S&P 500 stocks that have an S&P Quality rank of A- or better and that have a return on equity above the S&P 500 average — and then of course that have a Buy rating at Merrill Lynch, which generated some 39 stocks.
24/7 Wall St. decided to take an even closer look at this list. We set a hurdle at a minimum of 25% return on equity and a dividend yield with a minimum of 2.00%, and we screened out any company that had a market cap less than $10 billion. This took the list down to nine stocks when we kept the same screen criteria in a FINVIZ screener as well. In almost all cases, the Merrill Lynch price objective is higher than the consensus analyst targets from Thomson/First Call.
Altria Group Inc. (NYSE: MO) is now of course in nearly a duopoly for the big U.S. tobacco stocks. Merrill Lynch had its 2015 return on equity at 184.7%, versus over 200% in the FINVIZ screen. Its market cap is nearing $120 billion and its yield is over 3.7%. Altria has an official goal and an unofficial pledge to raise its dividend each year into the future. Altria shares were last seen trading at $60.72, with a consensus analyst price target of $65.14 and a 52-week trading range of $47.31 to $61.74. Merrill Lynch’s price objective is slightly above the consensus at $66.00.
Lockheed Martin Corp. (NYSE: LMT) was shown by Merrill Lynch as having 111% return on equity in the Merrill Lynch data, and it was 116% according to FINVIZ. This defense contractor has a dividend yield north of 3% and a market cap of $66 billion. Shares of Lockheed Martin were recently trading at $216.00, compared to a consensus price target of $234.87 and a 52-week range of $181.91 to $227.91. Merrill Lynch’s price objective is handily above the consensus at $250.00.
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