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 yield 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
Sprouts Farmers Market ( SFM Quick Quote SFM - Free Report) , Global Industrial Company ( GIC Quick Quote GIC - Free Report) , Boise Cascade ( BCC Quick Quote BCC - Free Report) , Group 1 Automotive ( GPI Quick Quote GPI - Free Report) and Lifeway Foods ( LWAY Quick Quote LWAY - Free Report) . Why Use DuPont?
Although one cannot play down the importance of normal ROE calculation, the fact remains that it does not always provide a complete picture. The DuPont analysis, in contrast, allows investors to assess the elements that play a dominant role in any change in ROE. It can help investors segregate companies with higher margins from those with high turnover. For example, high-end fashion brands generally survive on high margins as compared with retail goods, which rely on higher turnover.
In fact, it 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, the strength of a company can be misleading if it has a high debt load.
Therefore, 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 the 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 is an indication of how much debt a 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 market environments. • 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 seven stocks that made it through the screen: Sprouts Farmers Market: This Zacks Rank #2 company operates in a highly fragmented grocery store industry. It has a unique model that features fresh produce, a foods section and a vitamin department focused on overall wellness. You can see . the complete list of today’s Zacks #1 Rank stocks here
The average earnings surprise of SFM for the past four quarters is 14.26%.
Global Industrial Company: The company, through its operating subsidiaries, is a provider of industrial products principally in North America. It currently sports a Zacks Rank #1.
The average earnings surprise of GIC for the past four quarters is 4.92%.
Boise Cascade : The Zacks Rank #1 company operates as a wood product manufacturer and building material distributor.
The average earnings surprise of BCC for the past four quarters is 25.53%.
Group 1 Automotive: The Zacks Rank #2 company is one of the leading automotive retailers in the world, with operations primarily located in the United States and the U.K.
The average earnings surprise of GPI for the past four quarters is 7.96%.
Lifeway Foods: The Zacks Rank #1 company produces Kefir, a drinkable product similar to but distinct from yogurt in several flavors sold under the name Lifeway's Kefir.
The average earnings surprise of LWAY for the past four quarters is 141.67%.
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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