Sometimes you look at a number, scratch your head, and say "Can that be real?" That's the case with the companies in this week's screen, which feature outsize long-term growth in a key profitability measure.
The number in question is return on equity—a company's after-tax income for a fiscal year (after preferred stock dividends but before common stock dividends) divided by book value, expressed as a percentage. This is a widely followed efficiency gauge, since it signals how much profit a company is able to generate given the resources provided by its stockholders.
In this week's screen, we identified those stocks with a five-year average return on equity of greater than 40%.
To enhance the attractiveness of the names on our list, we next screened for those companies ranked 5 STARS (strong buy) by Standard & Poor's equity analysts. Stocks with that designation are expected to outperform the Standard & Poor's 500-stock index on a total return basis by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
The table at the end of the story lists the five names that emerged. We spotlight two of them here:
MEMC Electronic Materials (WFR)
We believe this worldwide producer of silicon wafers used in semiconductors for microelectronic applications will benefit from the rapid growth in the solar power industry, which we project will grow 30% per year through 2010. Demand for polysilicon, the raw material used in the production of solar cells, has exceeded supply, with spot prices soaring to $300 per kilogram (kg) now from $40 per kg in 2004. MEMC has signed long-term contracts with three solar power manufacturers to produce polysilicon and plans to double its capacity by 2010. We estimate revenues will increase 25% in 2007 and 26% in 2008. In addition to higher volume, we forecast better pricing due to a continued supply shortage of polysilicon.
Our per-share earnings estimate is $3.96 for 2008. We expect the company to report 2007 profits of $2.78 when it releases these numbers after the market closes on Jan. 24. The company reported profits of $1.61 a share for 2006.
Our 12-month target price of $101 is based on a p-e-to-growth ratio of 0.85 (using our 2008 estimate), a discount to that of the S&P 500 to reflect MEMC's higher risks.
Risks to our recommendation and target price include changes in governmental policy related to solar power technology, an expansion in industry capacity higher than expected, and a larger-than-expected slowdown in the global economy.
Mindray Medical International (MR)
The largest Chinese manufacturer of medical devices continues to show strength across all business segments and geographic regions, aided by new products, sales force expansion, and the opening of new sales offices overseas. We see its sales in China benefiting from the rise of private and government health-care spending, while international sales should benefit from competitive pricing.
Mindray intends to invest 10% of its revenues every year into research and development. It recently launched a biochemistry analyzer, which analyzes nutrients and byproducts of cell culture, and a portable ultrasound imaging device. It also plans to expand into defibrillators, immunoassay products (which measure substances in bodily fluids), and digital radiography.
We estimate operating earnings of 70¢ per American Depositary Share (ADS) in 2007 and 90¢ in 2008, vs. the 52¢ it earned in 2006.
Risks to our recommendation and target price include unfavorable changes in Chinese government regulations, FDA rejection of new products for sale in the U.S., and intensified competition.
Our 12-month target price of $49 reflects an above-average p-e-to-growth ratio of 1.8, assuming average annual earnings-per-ADS growth of 30% over the next three years, and our 2008 estimate.
Piskora is managing editor of U.S. Editorial Operations for Standard & Poor's .