Return on equity is an investor-favorite metric when it comes to cherry picking quality stocks. But ROE doesn’t always tell the complete story and an investor might get fooled by picking stocks based on this number. Thus, taking a step beyond the basic ROE and analyzing it at an advanced level or applying the DuPont technique seems to be an intriguing idea.
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?
The DuPont analysis allows investors to assess the elements that play a dominant role in any change in ROE. It can help investors to separate companies having higher margins from those having a 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 focuses on the company’s leverage status. A lofty ROE could be due to the overuse of debt. If this is the case, the strength of a company can be uncertain 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 gets the upper hand while finding out 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 15 stocks that made it through the screen:
Marine Products Corporation (MPX - Free Report) ): This Zacks Rank #1 company is the third-largest distributor of sterndrive powerboats in the United States. The stock belongs to a top-ranked Zacks industry (top 9%). You can see the complete list of today’s Zacks #1 Rank stocks here.
Sprouts Farmers Market Inc. (SFM - Free Report) ): The company is engaged in the retailing of natural and organic food primarily in the United States. The stock carries a Zacks Rank #2. The stock belongs to a top-ranked Zacks industry (top 28%).
Amedisys Inc. (AMED - Free Report) ): The company is a leading provider of healthcare in home. It hails from a top-ranked Zacks industry (top 39%) and sports a Zacks Rank #1.
Duluth Holdings Inc. (DLTH - Free Report) ): The company provides casual wear, workwear and accessories for men and women. The stock carries a Zacks Rank #2. It belongs to a top-ranked Zacks industry (top 14%).
Foot Locker Inc. (FL - Free Report) ): This is a leading global retailer of athletically inspired shoes and apparel. It has a Zacks Rank #2 and belongs to a top-ranked Zacks industry (top 34%).
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.
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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.