Investing 101: Analyzing Sources of Profitability with ROE

By
A A A
Share |

(List compiled by Alexander Crawford and Danny Guttridge. Accounting data sourced from Google Finance, all other data sourced from Finviz.)

Company profitability is a very important consideration for shareholders, but equally important are the sources of that profitability. Because profits can derive from different sources, and some are preferred over others, it is very important to analyze where changes in profitability are coming from.

One way to do this is by using DuPont analysis of return on equity (ROE) profitability.

ROE  can be broken up into three components such that increases in ROE can be attributed to those components.

ROE 
= (Net Profit/Equity) 
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity) 
= (Net Profit margin)*(Asset turnover)*(Leverage ratio)

Analyzing the sources of returns for a company, we can focus on companies with the following characteristics: Increasing ROE along with,

• Decreasing leverage, i.e. decreasing Asset/Equity ratio
• Improving asset use efficiency (i.e. increasing Sales/Assets ratio)
• Improving net profit margin (i.e. increasing Net Income/Sales ratio)

Companies passing all requirements are thus experiencing increasing profits due to operations and not to increased use of leverage.

A closer look at the terms used above:

Float short:  This is the percentage of share float that is currently being shorted, where share float  is the number of shares available for trading. 

RSI:  this measures the speed and change of price movements. It is often used as a momentum indicator, with a reading that ranges from 0 to 100. In general, RSI(14) above 70 signals a stock is overbought (i.e. prices might soon decline), and below 30 signals a stock is oversold (i.e. prices might soon rebound). 

To illustrate this analysis, we ran DuPont on companies that are being highly shorted (with short float above 10%) and technically oversold (with RSI(14) below 40).

Do you think these names are due for a rebound? Use this list as a starting-off point for your own analysis.

Analyze These Ideas (Tools Will Open In A New Window)

1. Access a thorough description of all companies mentioned
2. Compare analyst ratings for all stocks mentioned below
3. Visualize annual returns for all stocks mentioned

List sorted by market cap.

1. Garmin Ltd. (GRMN): Scientific & Technical Instruments Industry. Market cap of $6.12B. Float short at 19.99%. RSI(14) at 31.75. MRQ net profit margin has increased to 18.80% from 8.66% one year ago, MRQ Sales/Assets has increased to 0.13 from 0.12, and MRQ Assets/Equity has decreased to 1.23 from 1.39. The stock has gained 10.05% over the last year.

2. The St. Joe Company (JOE): Real Estate Development Industry. Market cap of $1.63B. Float short at 22.72%. RSI(14) at 30.73. MRQ net profit margin has increased to 19.20% from -85.79% one year ago, MRQ Sales/Assets has increased to 0.07 from 0.01, and MRQ Assets/Equity has decreased to 1.218 from 1.222. The stock is currently stuck in a downtrend, trading 6.3% below its SMA20, 11.76% below its SMA50, and 24.44% below its SMA200. The stock has performed poorly over the last month, losing 15.57%.

3. Diamond Foods, Inc. (DMND): Processed & Packaged Goods Industry. Market cap of $1.52B. Float short at 36.19%. RSI(14) at 29.72. MRQ net profit margin has increased to 3.47% from -3.08% one year ago, MRQ Sales/Assets has increased to 0.17 from 0.11, and MRQ Assets/Equity has decreased to 2.97 from 3.36. After a solid performance over the last year, DMND has pulled back during recent sessions. The stock is 10.04% below its SMA20 and 8.41% below its SMA50, but remains 15.68% above its SMA200. The stock has performed poorly over the last month, losing 10.03%.

4. Coinstar Inc. (CSTR): Specialty Retail Industry. Market cap of $1.42B. Float short at 34.01%. RSI(14) at 33.57. MRQ net profit margin has increased to 6.14% from 3.91% one year ago, MRQ Sales/Assets has increased to 0.37 from 0.26, and MRQ Assets/Equity has decreased to 2.58 from 2.73. Might be undervalued at current levels, with a PEG ratio at 0.93, and P/FCF ratio at 9.76. The stock is currently stuck in a downtrend, trading 15.16% below its SMA20, 11.15% below its SMA50, and 9.82% below its SMA200. It's been a rough couple of days for the stock, losing 12.42% over the last week.

5. Bio-Reference Laboratories Inc. (BRLI): Medical Laboratories & Research Industry. Market cap of $537.29M. Float short at 28.83%. RSI(14) at 28.32. MRQ net profit margin has increased to 5.68% from 5.24% one year ago, MRQ Sales/Assets has increased to 0.51 from 0.50, and MRQ Assets/Equity has decreased to 1.59 from 1.64. The stock is currently stuck in a downtrend, trading 5.19% below its SMA20, 10.58% below its SMA50, and 14.42% below its SMA200. The stock has lost 9.8% over the last year.

6. Constant Contact, Inc. (CTCT): Marketing Services Industry. Market cap of $530.46M. Float short at 27.69%. RSI(14) at 22.26. MRQ net profit margin has increased to 2.42% from -2.14% one year ago, MRQ Sales/Assets has increased to 0.29 from 0.27, and MRQ Assets/Equity has decreased to 1.36 from 1.37. The stock is currently stuck in a downtrend, trading 18.9% below its SMA20, 22.58% below its SMA50, and 34.4% below its SMA200. It's been a rough couple of days for the stock, losing 19.93% over the last week.

7. Hollysys Automation Technologies, Ltd (HOLI): Industrial Electrical Equipment Industry. Market cap of $341.40M. Float short at 26.23%. RSI(14) at 30.22. MRQ net profit margin has increased to 17.02% from 15.32% one year ago, MRQ Sales/Assets has increased to 0.13 from 0.09, and MRQ Assets/Equity has decreased to 1.68 from 1.73. The stock is a short squeeze candidate, with a short float at 26.23% (equivalent to 8.89 days of average volume). The stock is currently stuck in a downtrend, trading 31.62% below its SMA20, 31.13% below its SMA50, and 50.44% below its SMA200. It's been a rough couple of days for the stock, losing 20.13% over the last week.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks


Kapitall

Kapitall

More from Kapitall:

Related Videos

Stocks

Referenced

Most Active by Volume

74,972,696
  • $16.29 ▲ 1.24%
58,110,176
  • $63.0301 ▲ 2.92%
52,113,540
  • $4.30 ▲ 4.37%
45,053,607
  • $26.18 ▲ 3.40%
40,556,519
  • $3.22 ▲ 0.94%
33,697,770
  • $50.83 ▲ 1.90%
33,642,638
  • $4.56 ▲ 2.01%
31,530,460
  • $20.06 ▲ 11.88%
As of 4/22/2014, 04:07 PM