As coronavirus tensions are unnerving investors, hunting for some quality picks to stay unscathed by the recession-induced selloff would be a great idea. In this vein, betting on stocks that are rich in return on equity (ROE) can be rewarding.
ROE is one of the most coveted metrics among investors in search of profit-generating stocks. But ROE doesn’t always tell the complete story and an investor might make a mistake by selecting stocks based on this ratio. Thus, taking a step beyond the basic ROE and analyzing it at an advanced level or applying the DuPont technique seem a prudent decision.
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 the four stocks that made it through the screen:
Humana Inc. HUM: This Zacks Rank #2 company is one of the largest health care plan providers in the United States. It hails from a favorable Zacks industry (placed at the top 30% of total 250+ industries in the Zacks universe). You can see the complete list of today’s Zacks #1 Rank stocks here.
Semler Scientific Inc. SMLR: The Zacks Rank #2 medical risk-assessment company comes from a favorable Zacks industry (top 13%).
Vipshop Holdings Limited VIPS: The Zacks Rank #2online discount retailer for brands belongs to a favorable Zacks industry (top 15%).
Turtle Beach Corporation HEAR:The Zacks Rank #2 audio technology company belongs to a top-ranked Zacks sector (top 23%).
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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.
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Humana Inc. (HUM) : Free Stock Analysis Report
Turtle Beach Corporation (HEAR) : Free Stock Analysis Report
Vipshop Holdings Limited (VIPS) : Free Stock Analysis Report
Semler Scientific Inc. (SMLR) : Free Stock Analysis Report
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