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5 Top Stocks Based on DuPont Technique

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Return on Equity (ROE) is an important yardstick for investors searching for profitable stocks. ROE is a profitability ratio that measures the earnings that a company generates from its equity. Investors can follow the ROE trend in companies and compare this to historical or industry benchmarks to pick a winning stock.

Moreover, delving into the basics of ROE and analyzing it at a deeper level, with the help of DuPont analysis, could lead to better returns. The DuPont technique helps to determine the processes where the company operates efficiently and processes where improvement is necessary.

Here is how DuPont breaks down ROE into its different components:

ROE = Net Income/Equity

Net Income / Equity = (Net Income / Sales) * (Sales / Assets) * (Assets / Equity)

ROE = Profit Margin * Asset Turnover Ratio * Equity Multiplier

Why Use DuPont?

Although one can’t play down the importance of normal ROE calculation, the fact remains that it doesn’t always provide a complete picture. The DuPont analysis, on the other hand, allows investors to assess the elements that play a dominant role in any change in ROE. It can help investors to segregate companies having higher margins from those having high turnover. For example, high-end fashion brands generally survive on high margin as compared with retail goods, which rely on higher turnover.

In fact, it also sheds light on the company’s leverage status, which can go a long way in selecting stocks poised for gains. A lofty ROE could be due to the overuse of debt. Thus, the strength of a company can be misleading if it has a high debt load.

So, an investor confined solely to an ROE perspective may be confused if he or she has to judge between two stocks of equal ratio. This is where DuPont analysis wins over and spots the better stock.

Investors can simply do this analysis by taking a look at the company’s financials. However, looking at financial statements of each company separately can be a tedious task. Screening tools like Zacks Research Wizard can come to your rescue and help you shortlist the stocks that look impressive with a DuPont analysis.

Screening Parameters

Profit Margin more than or equal to 3: As the name suggests, it is a measure of how profitably the business is running. Generally, it is the key contributor to ROE.

Asset Turnover Ratio more than or equal to 2: It allows an investor to assess management’s efficiency in using assets to drive sales.

Equity Multiplier between 1 and 3: It’s an indication of how much debt the company uses to finance its assets.

Zacks Rank less than or equal to 2: Stocks having a Zacks Rank #1 (Strong Buy) or 2 (Buy) generally perform better than their peers in all types of market environment. You can see the complete list of today’s Zacks #1 Rank stocks here.

Current Price more than $5: This screens out the low priced stocks. However, when looking for lower priced stocks, this criterion can be removed.

Here are five of the 11 stocks that qualified the screen:

Best Buy Co. Inc. (BBY - Free Report) : The company is a leading retailer. The stock carries a Zacks Rank #1 and a VGM (Value-Growth-Momentum) score of A.

Nutrisystem Inc. : This Zacks Rank #1 stock is a provider of weight management products and services. Though its Zacks Industry Rank is in the bottom 24%, the stock has a Momentum score of A.

Sinopec Shanghai Petrochemical Co. Ltd. (SHI - Free Report) : It is China's largest petrochemical company. Its Zacks Industry Rank is in the top 30%.The stock has a VGM of A and sports a Zacks Rank #1.

Comfort Systems USA Inc. (FIX - Free Report) : The company is a provider of heating, ventilation and air conditioning installation and maintenance services. It has a Zacks Rank #2 and the Zacks Industry Rank is in the top 13%. The stock has a VGM score of A.

American Woodmark Corp (AMWD - Free Report) : The company is the manufacturer and distributer of kitchen cabinets for remodeling and new home construction markets. Its Zacks Industry Rank is in the top 30%. The stock has a Zacks Rank #2.

Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and back testing software.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

Click here to sign up for a free trial to the Research Wizard today.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks' portfolios and strategies are available at: https://www.zacks.com/performance.

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