Key Takeaways
- DuPont analysis breaks ROE into margins, efficiency and leverage to reveal true strength.
- Screening found five picks: CASY, ECG, GRDN, EXPD and MAMA with solid fundamentals.
- Strong earnings surprises and healthy DuPont metrics signal potential upside ahead.
Return on equity (ROE) is one of the most favored metrics of investors. It is a profitability ratio that measures earnings generated by a company from its equity. Investors can follow the ROE trend in companies and compare this to 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 that 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
The screener yields winning stocks like Casey’s General Stores (CASY – Free Report) , Everus Construction Group Inc. (ECG – Free Report) , Guardian Pharmacy Services Inc. (GRDN – Free Report) , Expeditors International of Washington (EXPD – Free Report) and Mama’s Creations Inc. (MAMA – Free Report) .
Why Use DuPont?
Although one can’t play down the importance of normal ROE calculation, the fact remains that it doesn’t always provide 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 margins as compared with retail goods, which rely on higher turnover.
In fact, it also sheds light on the company’s leverage status, which can go a long way in selecting stocks poised for gains. 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 with equal ratios. This is where DuPont analysis wins over and spots 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.
Screening Parameters
• 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 environments.
• 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 out of 11 stocks that made it through the screen:
Casey’s General Stores: The Zacks Rank #1 company operates convenience stores primarily under the Casey’s and Casey’s General Store names in 19 states, mainly Iowa, Missouri and Illinois. You can see the complete list of today’s Zacks #1 Rank stocks here.
The average earnings surprise of CASY for the past four quarters is 18.40%.
Everus Construction Group: The Zacks Rank #1 company is providing a full spectrum of construction services through its electrical and mechanical, and transmission and distribution specialty contracting services principally in the United States.
The average earnings surprise of ECG for the past four quarters is 61.97%.
Guardian Pharmacy Services:The Zacks Rank #2 company is a long-term care pharmacy services company that provides an extensive suite of technology-enabled services designed to help residents of long-term healthcare facilities.
The average earnings surprise of GRDN for the past four quarters is 16.65%.
Expeditors International of Washington: The Zacks Rank #1 company is a leading third-party logistics provider.
The average earnings surprise of EXPD for the past four quarters is 13.96%.
Mama’s Creations: The Zacks Rank #2 company manufactures and distributes fresh deli-prepared foods sold through more than 12,000 grocery, mass, club and convenience stores across the United States.
The average earnings surprise of MAMA for the past four quarters is 129.17%.
