Friday, July 19, 2002

Buy Them While Their Returns Are Weak

One investing rule of thumb says to look for companies with high returns on equity. The approach is perfectly logical.

Return on equity (ROE), calculated by dividing net income by shareholder equity during a particular period, measures the return that management has produced on the money invested into the business. It makes sense that investors, i.e. shareholders, would seek out companies with healthy double-digit returns on equity.

So, why would anyone consider a company with low ROE? For starters, companies with low ROE may get overlooked or beaten down more than warranted because of their lackluster returns. And, sometimes, a slump in profitability may not be representative of long-term potential.

Take, for example, Andrew Corporation, a maker of cables, antennas, power amplifiers and other equipment for wireless and fixed-line communications. On a latest 12-month basis, return on equity for the Orland, Park, Ill.-based company stands at 9%, down from a three-year average of 11% and a five-year average of 15%.

Given the ongoing drought in capital spending and the ugly overall situation in telecommunications, it's not difficult to understand why Andrew's profits have suffered. The market, however, may have treated the stock a bit too harshly. At a recent $13, Andrew shares have fallen 47% since hitting a 52-week high in January.

If investors warm again to wireless stocks, Andrew looks poised to benefit. The company has taken advantage of its healthy balance sheet to make acquisitions and shore up its market position. In early June, the company completed its $470 million acquisition of Celiant, thereby becoming the leading U.S. maker of wireless-signal amplifiers.

To assemble our list of companies with low ROEs but promising prospects, we screened for companies with the following characteristics: ROE in the single digits and below their three-year and five-year averages; latest 12-month price-to-earnings multiple of 30 or less; and market capitalization greater than $500 million.

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