Return on equity (ROE) is one of the most-favored metrics of investors. It is a profitability ratio that measures the earnings generated by a company from its equity. Investors can follow the ROE trend in companies and compare this to the historical or industry benchmarks to pick a winning stock.
However, stepping beyond the basic ROE and analyzing it at an advanced level could lead to 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
Sanderson Farms SAFM, Pool Corp. POOL, Casey's General Stores CASY, Global Industrial Company GIC and Landstar System LSTR are some of winning stocks screened based on the afore-mentioned criteria.
Why Use DuPont?
Although one cannot brush off the importance of normal ROE calculation, the fact remains that it doesn’t always portray a complete picture. The DuPont analysis, on the other hand, allows investors to assess the elements that play a dominant role in any change in ROE. It can help investors to segregate companies with 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.
And one of the ROE components – equity multiplier (explained below) – can help you judge how burdened a company is with debts. 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.
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 wins over and spots the better stock.
Investors can simply do this analysis by taking a look at a 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 the 17 stocks that made it through the screen:
Sanderson Farms: This Zacks Rank #1 is a poultry processing company that produces, processes, markets and distributes fresh and frozen chicken products. You can see the complete list of today’s Zacks #1 Rank stocks here.
Sanderson Farms has been diversifying its offerings to meet changing preferences of consumers, who are looking for more health and wellness products.
Pool Corp: This is the world's largest wholesale distributor of swimming pool supplies, equipment and related product. The stock carries a Zacks Rank #1.
Pool reports operations under two segments — the Base Business segment (95.6% of third-quarter 2021 revenues) and the Excluded segment i.e. sale centers excluded from Base Business (4.4%).
Casey's General Stores: The company operates convenience stores under the Casey's and Casey's General Store names in 16 Midwestern states, mainly Iowa, Missouri and Illinois. The stock has a Zacks Rank #2.
Casey's General Storeoffers a variety of food selection (including freshly prepared foods such as pizza, donuts and sandwiches), beverages, tobacco and nicotine products, health and beauty aids, school supplies, housewares and pet supplies.
Global Industrial Company:Global Industrial Company, through its operating subsidiaries, is a provider of industrial products principally in North America. GIC has a Zacks Rank #2.
Global Industrial Company, formerly known as Systemax Inc., is based in NY.
Landstar System:The Zacks Rank #2 Landstar System, Inc. is an asset-light provider of integrated transportation management solutions, incorporated in 1991. Based in Jacksonville, FL, the company provides services throughout the United States, Canada, Mexico as well as other countries in North America.
Landstar System delivers safe, specialized transportation services to a broad range of customers utilizing a network of over 1,200 independent commission sales agents as well as over 66,000 third-party capacity owners.
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.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Pool Corporation (POOL) : Free Stock Analysis Report
Sanderson Farms, Inc. (SAFM) : Free Stock Analysis Report
Casey's General Stores, Inc. (CASY) : Free Stock Analysis Report
Global Industrial Company (GIC) : Free Stock Analysis Report
Landstar System, Inc. (LSTR) : Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research