Return on equity is one of the most sought-after metrics by investors. The metric enables investors to differentiate between a profit-churner and a profit-burner. It is a profitability ratio that measures the earnings that a company generates from its equity.
To shortlist these gems, one can look at the DuPont technique to analyze basic ROE at an advanced level. 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.
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 the 21 stocks that made it through the screen: MEDIFAST INC (This Zacks Rank #2 company is known for its leading health and wellness community — OPTAVIA — which provides Lifelong Transformation, One Healthy Habit at a Time lifestyle solutions. Given consumers’ rising inclination toward health, the OPTAVIA lifestyle solution and coaching support system bode well. You can see MED Quick Quote MED - Free Report) : . the complete list of today’s Zacks #1 Rank stocks here Pool Corporation (This Zacks Rank #1 company is the world's largest wholesale distributor of swimming pool supplies, equipment and related products. In addition, the company is a leading regional wholesale distributor of irrigation and landscape products. POOL Quick Quote POOL - Free Report) : Caseys General Stores Inc. ( This Zacks Rank #2 company operates convenience stores under the Casey's and Casey's General Store names in 16 Midwestern states, mainly Iowa, Missouri and Illinois. CASY Quick Quote CASY - Free Report) : XPEL, Inc. (The Zacks Rank #2 company is a provider of protective films and coatings, which include automotive paint protection film, surface protection film, automotive and architectural window films, and ceramic coatings. XPEL Quick Quote XPEL - Free Report) : Landstar System Inc. (It is an asset-light provider of integrated transportation management solutions, incorporated in 1991. Based in Jacksonville, FL, the company provides services throughout the United States, Canada, Mexico as well as other countries in North America. It carries a Zacks Rank #2. LSTR Quick Quote LSTR - Free Report) :
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. 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