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Return on equity (ROE) is one of the most coveted metrics among investors in search of profit-generating stocks. Delving into the basic ROE, with the help of DuPont analysis, before shortlisting stocks could lead to even better returns.It’s basically taking ROE apart to examine how it works. 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)
Although one can’t stress the importance of ROE enough, the fact remains that it doesn’t always provide a complete picture. But the DuPont analysis allows investors to assess which of the elements is dominant in any change in ROE. It can help investors to segregate companies having high 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 a 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, ROE of a company can be misleading if it has a high debt burden.
So, an investor looking at two stocks only from an ROE perspective will be impartial if the values are the same. However, DuPont analysis will help to differentiate between the two stocks and find the better one. Thus, a company with a healthy mix of all the three ratios – profit margin, asset turnover ratio and equity multiplier – will be the most alluring.
DuPont analysis is not very difficult, as the required numbers are available in the company income statement and balance sheet of a company.
However, looking at financial statements of each company separately can be a tedious task. Screening tools like Zacks Research Wizard can easily 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.
• 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 13 stocks that made it through the screen:
Nutrisystem Inc. : This Zacks Rank #1 company is a provider of weight management products and services. It belongs to a Zacks Industry Rank is in the top 20%.
NVR Inc. (NVR - Free Report) : The Zacks Rank #1 holding company operates in two business segments: construction and marketing of homes, and in financial services. It belongs to a Zacks Industry Rank in the top 12%.
Ross Stores Inc. (ROST - Free Report) : This operator of a chain of off-price retail apparel and home accessories stores carries a Zacks Rank #2. The Zacks Industry Rank for the stock is in the top 26%.
Best Buy Co. Inc. (BBY - Free Report) : The Zacks Rank #2 company operates in a single business segment, selling personal computers and other home office products and related accessories principally through its retail stores. The Zacks Industry Rank is in the top 5%.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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.
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.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »
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5 Stock Picks from Analyzing ROE the DuPont Way
Return on equity (ROE) is one of the most coveted metrics among investors in search of profit-generating stocks. Delving into the basic ROE, with the help of DuPont analysis, before shortlisting stocks could lead to even better returns.It’s basically taking ROE apart to examine how it works. 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
Inside DuPont’s Effectiveness
Although one can’t stress the importance of ROE enough, the fact remains that it doesn’t always provide a complete picture. But the DuPont analysis allows investors to assess which of the elements is dominant in any change in ROE. It can help investors to segregate companies having high 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 a 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, ROE of a company can be misleading if it has a high debt burden.
So, an investor looking at two stocks only from an ROE perspective will be impartial if the values are the same. However, DuPont analysis will help to differentiate between the two stocks and find the better one. Thus, a company with a healthy mix of all the three ratios – profit margin, asset turnover ratio and equity multiplier – will be the most alluring.
DuPont analysis is not very difficult, as the required numbers are available in the company income statement and balance sheet of a company.
However, looking at financial statements of each company separately can be a tedious task. Screening tools like Zacks Research Wizard can easily 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.
• 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 13 stocks that made it through the screen:
Sanderson Farms Inc. : This is Zacks Rank #2 company engaged in poultry processing. It belongs to a Zacks Industry Rank in the top 5%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Nutrisystem Inc. : This Zacks Rank #1 company is a provider of weight management products and services. It belongs to a Zacks Industry Rank is in the top 20%.
NVR Inc. (NVR - Free Report) : The Zacks Rank #1 holding company operates in two business segments: construction and marketing of homes, and in financial services. It belongs to a Zacks Industry Rank in the top 12%.
Ross Stores Inc. (ROST - Free Report) : This operator of a chain of off-price retail apparel and home accessories stores carries a Zacks Rank #2. The Zacks Industry Rank for the stock is in the top 26%.
Best Buy Co. Inc. (BBY - Free Report) : The Zacks Rank #2 company operates in a single business segment, selling personal computers and other home office products and related accessories principally through its retail stores. The Zacks Industry Rank is in the top 5%.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »