Return on equity (ROE) can be considered one of the most reliable metrics for investors. 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’s how DuPont breaks down ROE into 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 drive any change in ROE. It helps investors distinguish companies with 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 is in question if it has a high debt load. This is where DuPont analysis wins while picking 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. Here, screening tools like Zacks Research Wizard can come in handy.
• Profit Margin more than or equal to 3: As the name suggests, it is a measure of how profitably a 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 seven stocks that made it through the screen:
NVR Inc. (NVR - Free Report) : This Zacks Rank #2 company operates in two business segments: homebuilding and mortgage banking. The stock belongs to a top-ranked Zacks industry (top 5%). You can see the complete list of today’s Zacks #1 Rank stocks here.
MEDIFAST Inc. (MED - Free Report) : The company is a leading manufacturer and distributor of clinically-proven healthy living products and programs. The stock carries a Zacks Rank #2. It comes from a top-ranked Zacks sector (top 38%).
BMC Stock Holdings Inc. (BMCH - Free Report) : The company provides diversified building products and services to professional builders and contractors, primarily in the residential housing market. The stock has a Zacks Rank #1.
Universal Forest Products Inc. (UFPI - Free Report) : The company is a holding company of businesses that combine to create one of the largest producers of wood and wood-alternative products in North America. The stock carries a Zacks Rank #2 and belongs to a top-ranked Zacks sector (top 50%).
EMCOR Group Inc. (EME - Free Report) : The company is a provider of critical infrastructure systems. It has a Zacks Rank #2 and it belongs to a top-ranked Zacks industry (top 36%).
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.