Return on equity (ROE) can be considered one of the most reliable metrics when investors set out to select quality stocks. That said, we would like to note that the basic ROE calculation doesn’t always tell the complete story and an investor might get misled 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
Inside the Strength of DuPont
The DuPont analysis allows investors to evaluate the elements that are the driving factors in any change in ROE. It can help investors to separate companies having higher margins from those having a high 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 relying solely on basic ROE may be confused if he or she has to judge between two stocks of equal ratio. This is where DuPont analysis wins while finding out 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’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 10 stocks that made it through the screen:
Amedisys Inc. (AMED - Free Report) : This Zacks Rank #2 company is a leading provider of healthcare in the home with a vision of becoming the premiere solution for patients. The stock belongs to a top-ranked Zacks industry (top 41%). You can see the complete list of today’s Zacks #1 Rank stocks here.
Foot Locker Inc. (FL - Free Report) : The company is a leading global retailer of athletically inspired shoes and apparel. The stock carries a Zacks Rank #2. It comes from a top-ranked Zacks industry (top 21%).
Shoe Carnival Inc. (SCVL - Free Report) : The company is one of the nation's largest family footwear retailers. The stock hails from a top-ranked Zacks industry (top 21%).
Tractor Supply Company (TSCO - Free Report) : The company is the largest operator of rural lifestyle retail stores in America. The stock carries a Zacks Rank #2 and belongs to a top-ranked Zacks industry (top 25%).
Caseys General Stores Inc. (CASY - Free Report) : The company and its wholly owned subsidiaries operate convenience stores under the names Casey's and Casey's General Store. It has a Zacks Rank #1 and belongs to a top-ranked Zacks industry (top 1%).
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.