Return on equity is an investor-favorite metric
when it comes to cherry-picking quality stocks. But ROE doesnât
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
ROE = Net Income/Equity
Net Income / Equity = (Net Income / Sales) * (Sales / Assets) *
(Assets / Equity)
ROE = Profit Margin * Asset Turnover Ratio * Equity Multiplier
Why Use DuPont?
Although one canât play down the importance of
normal ROE calculation, the fact remains that it doesnât 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
having higher margins from those having high turnover. For example,
high-end fashion brands generally survive on high margin as
compared with retail goods, which rely on higher turnover.
In fact, it also sheds light on the companyâs
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
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 the companyâs 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
â¢ 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.
â¢ Asset Turnover Ratio more than or equal to 2: It
allows an investor to assess managementâs efficiency in using
assets to drive sales.
â¢ Equity Multiplier between 1 and 3: Itâs an
indication of how much debt the company uses to finance its
â¢ 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.
â¢ 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 10 stocks that made it through the screen:
Medifast Inc MED: This company
has a Zacks Rank #2 and is a leading manufacturer and distributor
of clinically proven healthy living products and programs. You can
see the complete list of todayâs Zacks #1 Rank stocks
Shoe Carnival Inc. SCVL: This
company carries a Zacks Rank #2 and is one of the nation's largest
family footwear retailers, offering a broad assortment of
moderately priced dress, casual and athletic footwear for men,
women and children with emphasis on national and regional name
brands. It belongs to a top-ranked Zacks sector (top 36%).
Marine Products Corporation MPX:
This Zacks #2 Ranked company is the third-largest distributor of
sterndrive powerboats in the United States. It belongs to a
top-ranked Zacks industry (top 7%).
Amedisys Inc. AMED: This
provider of healthcare in the home holds a Zacks Rank of 2. The
stock hails from the top-ranked Zacks industry (top 28%).
NVR Inc. NVR: This Zacks #1
Ranked company operates in two business segments: homebuilding and
mortgage banking. It comes from a top-ranked Zacks industry (top
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
Disclosure: Performance information for
Zacksâ portfolios and strategies are available at:
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
NVR, Inc. (NVR) : Free
Stock Analysis Report
MEDIFAST INC (MED) : Free
Stock Analysis Report
Marine Products Corporation
(MPX) : Free Stock Analysis Report
Amedisys, Inc. (AMED) :
Free Stock Analysis Report
Shoe Carnival, Inc. (SCVL)
: Free Stock Analysis Report
To read this article on
Zacks.com click here.
Zacks Investment Research