RReturn on equity (ROE) is one of the most popular indicators for investors. It is a profitability ratio that measures the profits generated by a company from its equity. Investors can track the ROE trend of companies and compare it to historical or industry benchmarks to pick a winning stock.
However, going beyond basic ROE and analyzing it at an advanced level could lead to even better returns. This is where DuPont analysis comes in. It is a method of analysis that looks at three major elements—operational management, asset management, and capital structure—related to financial condition. from a company. Below we show how DuPont breaks down ROE into its various components:
ROE = Net Profit/Equity
Net Profit / Equity = (Net Profit / Sales) * (Sales / Assets) * (Assets / Equity)
ROE = profit margin * asset turnover ratio * equity multiplier
The filter yields winning stocks like Sanderson Farms Inc. SAFM, MEDIFAST MED, Skyline SKY, Hudson Global HSON and Expeditors International of Washington EXPD.
Why use DuPont?
While the importance of the normal ROE calculation cannot be understated, the fact remains that it does not always provide the complete picture. DuPont’s analysis, on the other hand, allows investors to assess the elements that play a predominant role in any evolution of ROE. This can help investors separate companies with higher margins from those with high turnover. For example, high-end fashion brands typically survive with a high margin compared to retail products, which rely on higher revenue.
In fact, it also sheds light on the debt status of the company, which can go a long way toward picking stocks that are ready to generate gains. A high ROE could be due to overuse of debt. Thus, the strength of a company can be misleading if it has high debt.
Thus, an investor confined solely to an ROE perspective may be confused when judging between two stocks of equal ratio. This is where DuPont’s analysis wins out and picks out the best stock.
Investors can simply do this analysis by looking at the company’s financial statements. However, reviewing each company’s financial statements separately can be a tedious task. Screening tools like Zacks Research Wizard can come to your rescue and help you shortlist stocks that look impressive with a DuPont analysis.
• Profit margin greater than or equal to 3: As the name suggests, it is a measure of business profitability. Generally, it is the main contributor to ROE.
• Asset turnover ratio greater than or equal to 2: It allows an investor to gauge management’s effectiveness in using assets to drive sales.
• Equity multiplier between 1 and 3: It is an indication of the amount of debt the company uses to finance its assets.
• Zacks rank less than or equal to 2: Stocks with a Zacks rank of #1 (strong buy) or 2 (buy) generally perform better than their peers in all types of market environments.
• Current price above $5: This filters out low priced stocks. However, when looking for low-priced stocks, this criterion can be removed.
Here are five of the nine stocks that crossed the screen:
Sanderson Farms Inc. (SAFM): This Zacks Rank #1 company produces, processes, markets and distributes fresh and frozen chicken products. You can see the full list of today’s Zacks #1 Rank stocks here.
SAFM’s average earnings surprise for the last four quarters is 60.49%.
MEDIFAST (MED): The Zacks rank #2is a leading manufacturer and marketer of clinically proven healthy living products and programs.
MED’s average earnings surprise for the last four quarters is 12.94%.
Horizon (SKY): The Zacks Rank #1 company designs, produces and distributes manufactured homes and recreational vehicles.
SKY’s average earnings surprise for the past four quarters is 45.32%.
Hudson Global (HSON): Zacks Rank #2 company provides recruitment and related talent solutions worldwide.
HSON’s average earnings surprise for the last four quarters is 129.60%.
Expeditors International of Washington (EXPD): The Zacks Rank #2 Companyis a leading third-party logistics provider.
EXPD’s average earnings surprise for the past four quarters is 21.38%.
You can get the rest of the stocks on this list by signing up for your free 2-week trial to Research Assistant now and start using this screen in your own trading. Moreover, you can also create your own strategies and test them before diving into investing.
The research assistant is a great starting point. It’s easy to use. Everything is in plain language. And it’s very intuitive. Start your search assistant trial today. And the next time you’re reading an economic report, open up the research assistant, plug in your findings, and see what gems come out.
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 the options mentioned herein. An affiliated investment adviser may hold or have shorted securities and/or hold long and/or short positions in options mentioned herein.
Disclosure: Information on the performance of Zacks portfolios and strategies is available at: https://www.zacks.com/performance.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.