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3 low return on equity companies to avoid

Last month I identified nine of the highest return on equity companies to consider owning today, using industry data from valuation guru Aswath Damodaran.

To recap, the average return on equity for the almost 7,500 (U.S.) companies in the data was 10% for the 12 months to January 2016.

Companies producing high returns on shareholder equity have more ability to reinvest and grow over time, compounding shareholder wealth and paying out dividends. On the other hand, industries with low returns on equity (ROE) are less preferable and best avoided.

Five of the lowest returning industries in 2105 were:

Number

Industry

ROE

1

Oil/Gas (Production and Exploration)

-27%

2

Precious Metals

-4%

3

Telecom (Wireless)

-3%

4

Financial Svcs. (Non-bank & Insurance)

-1%

5

Publishing & Newspapers

4%

Commodities

Clearly, when it comes to the low returning commodities we need to account for the cyclical nature of the industries. Oil and gas companies were bludgeoned by low prices in 2015 after years of doing well. In my view the low returns are likely to persist for some time and energy companies are generally worth avoiding.

Precious metals are a different story. True, they were a rubbish investment in 2015, but gold in particular has been a star in 2016 which should lead to vastly improved returns for many producers this year.

Telecom (Wireless)

The ASX has few companies classified as wireless telecom, the most relevant being BigAir Group Limited (ASX: BGL). The company provides wireless internet services through its network of fixed radio transceivers and reported ROE of 10% in 2015, bang-on average for all industries.

Financial Services (non-Bank & Insurance)

Moving further down the list we come across Financial Services, which is interesting because 2015 was a good year for many ASX listed companies in this industry. This includes Money3 Corporation Limited (ASX: MNY), FlexiGroup Limited (ASX: FXL) and Challenger Ltd (ASX: CGF), all of which recorded above average ROEs in their 2015 financial years.

Publishing & Newspapers

Publishing is an industry filled with companies either struggling for relevance or sinking money into questionable digital strategies, which is reflected in returns on equity.

Fairfax Media Limited (ASX: FXJ) returned just 3.6% in the 2015 financial year, while APN News and Media Limited (ASX: APN) reported a loss and negative return on equity, but even in 2014 it returned just 4%. PMP Limited (ASX: PMP), a printing and distribution company reported, just 2.4%.

Avoid, avoid and avoid.

Foolish takeaway

Knowing what to avoid is just as important as knowing what to buy when it comes to investment success, so be sure to check a prospective investment is going to give you the best chance of producing returns and compounding your wealth.

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Motley Fool contributor Regan Pearson owns shares of FlexiGroup Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.