Buy Hold Sell: 3 stocks with high ROEs (and 2 fundie favourites)

In this high-risk, high-inflation, high interest rate world, profitability has never been so important. Companies know this too, meaning they may go to incredible lengths to present the most positive picture possible of financial health or risk being beaten down by short sellers otherwise. 

One measure of financial health is return on equity, or ROE for short. This is calculated by dividing a company's net income (revenues minus expenses and taxes) by shareholder equity (a company's total assets minus its total liabilities), helping investors gauge how efficiently a company generates its profits. 

Generally, the higher the ROE, the better a company is at converting investor capital into profits. But it also depends on the sector average (typically, the sector average or above is considered a "good" ROE). 

So in this episode, Livewire's Ally Selby took the Buy Hold Sell virginities of LSN Capital's Nick Sladen and Elvest's Adrian Ezquerro for their analysis of three stocks with impressive ROE. 

Plus, they also named their highest conviction stock pick for the year ahead. 

Note: This episode was filmed on Wednesday 23 August 2023. You can watch the video, listen to the podcast or read an edited transcript below. 

Edited Transcript 

Ally Selby: Hey, how are you doing, and welcome to Livewire's Buy Hold Sell. I'm Ally Selby and today, we'll be taking a look at three stocks with some really impressive return-on-equity over the next 12 months. Plus, we'll also be asking our guests to name their highest conviction pick for the year ahead. To do that, we are joined by LSN Capital's Nick Sladen and Elvest's Adrian Ezquerro. 

Lovisa Holdings (ASX: LOV)

Ally Selby: First up today, we have Lovisa Holdings. Its return on equity is forecast to be around 121% over the next 12 months. For context, the industry average is around 24%. Nick, I'm going to start with you today. Is it a buy, hold, or sell?

Nick Sladen (HOLD): It's a hold for me, Ally. It's a fantastic fast fashion story and they've just recently opened their 800th store. They're opening over three stores per week so they're certainly not standing still. But we're a bit cautious on the global consumer and on 27-times earnings, it's a hold for us. 

Ally Selby: Its share price has risen around 25% over the past 12 months. Over to you Adrian, is it a buy, hold, or sell?

Adrian Ezquerro (BUY): Lovisa's a buy for us. We think it's a wonderful company and as you've noted, it's highly profitable and it's a wonderful example of self-funded growth. We think there's a real opportunity to approximately triple its global store footprint over the coming decade. Of course, that comes with execution risk but the store-level economics of Lovisa is exceptional. It's currently on a reasonable free cash flow yield and we think that ratchets materially higher as they further roll out their store network. 

OFX Group (ASX: OFX)

Ally Selby: Ok, next up, we have OFX Group. It has a forecast return on equity of around 20% which is around the industry average. Adrian, staying with you, is it a buy, hold, or sell?

Adrian Ezquerro (SELL): Perhaps it's a bit harsh but OFX is a sell for us. It listed on the ASX about a decade ago and over that same time frame, operating margins have halved. We actually think that is reflective of quite a competitive global transfers market. We do give credit to management for recent execution. A lot of that growth has come from M&A though and we think the risk of competitive erosion remains for investors. Therefore, it's a sell for us. 

Ally Selby: It's been a difficult 12 months for OFX Group. Its share price has fallen around 30%. Over to you Nick, is it a buy, hold, or sell? 

Nick Sladen (BUY): We think it's a buy. It's trading on around 12 times earnings, which is an attractive multiple. They recently gave an AGM trading update where net operating income was up 18% on the prior corresponding period last financial year. They've shown some really strong improvements in their corporate business. 

This business has moved from predominantly a consumer business to a corporate business over the last decade since they have been listed. The consumer business, which has had some challenges, started to improve a little bit better. From our perspective, the valuation looks good and we think there's a good opportunity for them to take share from other global payments businesses and it's a buy from our perspective. 

Pro Medicus (ASX: PME)

Ally Selby: Last up today, we have healthcare darling Pro Medicus. It has a return on equity of 45% over the next 12 months. The industry average is around 10%. Staying with you Nick, is it a buy, hold, or sell? 

Nick Sladen (SELL): ProMedicus has done a magnificent job growing its business globally and executed terrifically well. But from a valuation perspective, it's on over 90-times earnings and 60-times EV-to-EBITDA. We've got other opportunities from our perspective so it's a sell.

Ally Selby: Its share price has risen around 37% over the past 12 months. Adrian, last one for you, is it a buy, hold, or sell?

Adrian Ezquerro (SELL): Pro Medicus is also a sell for us. We tend to agree with Nick. We think it's an exceptional business and they have a wonderful market position within US diagnostic imaging particularly within academic hospitals. 

It has the hallmarks of quality - very profitable, higher margin business, strong balance sheet, and it's also founder-led. There's a lot to like about the business but the reality is that we think its valuation more than captures that quality so it's a sell for us. 

Adrian's Pick: Navigator Global Investments (ASX: NGI)

Our pick is Navigator Global Investments. Navigator is an alternative asset manager. In more recent times, they've been building up their strategic division and this basically owns stakes in a range of other asset management firms. You'd liken it to the Pinnacle (ASX: PNI) model here in Australia - which is highly profitable and in the case of Navigator, it's becoming the dominant earnings driver for the business. 

We like it at the moment because it's currently presenting a free cash flow yield in excess of 15%, which is obviously attractive. And that's after the deal to acquire the remaining stake of a strategic portfolio from Dyal Capital Partners. 

Navigator enters 2024 with a clean balance sheet, US$26 billion of assets under management, and a great ability to grow into a significant pipeline of opportunity. We think it's an under-the-radar small cap and therefore, it's a buy for us.

Nick's Pick: IPH Ltd (ASX: IPH)