Return on equity (ROE) is one of the most favored metrics of investors. It is a profitability ratio that measures earnings generated by a company from its equity. Investors can follow the ROE trend in companies and compare this to historical or industry benchmarks to pick a winning stock.
However, stepping beyond the basic ROE and analyzing it at an advanced level could lead to even better returns. Here is where the DuPont analysis comes into play. It is an analytical method, which examines three major elements – operating management, management of assets and the capital structure – related to the financial condition of a company. Below we show 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
The screener yields winning stocks like UFP Industries (
UFPI Quick Quote UFPI - Free Report) , MEDIFAST ( MED Quick Quote MED - Free Report) , Skyline ( SKY Quick Quote SKY - Free Report) , Hudson Global ( HSON Quick Quote HSON - Free Report) and Expeditors International of Washington ( EXPD Quick Quote EXPD - Free Report) . 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 13 stocks that made it through the screen: UFP Industries (This Zacks Rank #2 UFP Industries, Inc. is a holding company with its subsidiaries throughout North America, Europe, Asia and Australia. The company supplies wood, wood composite and other products in retail, industrial, and construction market. You can see UFPI Quick Quote UFPI - Free Report) : . the complete list of today’s Zacks #1 Rank stocks here
The average earnings surprise of the past four quarters of UFPI is 48.13%.
MEDIFAST (The Zacks Rank #2 company is a leading manufacturer and distributor of clinically-proven healthy living products and programs. MED Quick Quote MED - Free Report) :
The average earnings surprise of the past four quarters of MED is 12.94%.
Skyline ( SKY Quick Quote SKY - Free Report) : The Zacks Rank #2 company designs, produces and distributes manufactured housing and recreational vehicles.
The average earnings surprise of the past four quarters of SKY is 45.32%.
Hudson Global (The Zacks Rank #2 company provides recruitment and related talent solutions worldwide. HSON Quick Quote HSON - Free Report) :
The average earnings surprise of the past four quarters of HSON is 129.60%.
Expeditors International of Washington (The Zacks Rank #2 company is a leading third-party logistics provider. EXPD Quick Quote EXPD - Free Report) :
The average earnings surprise of the past four quarters of EXPD is 21.38%.
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