In a market, complacency levels may falter any time if medical metrics worsen or stimulus hope stalls. Herein, picking the right stock becomes a challenge. In such a scenario, return on equity is a proven metric to guide investors to the right stock.
The metric enables investors to differentiate between a profit-churner and a profit-burner. It is a profitability ratio that measures the earnings that a company generates from its equity.
But to fine-tune this basic concept, one can depend on DuPont analysis. This theory will take investors a step higher and better pick some quality stocks.
Here is 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
Inside the Strength of DuPont
The DuPont analysis allows investors to evaluate the elements that are the driving factors in any change in ROE. It can help investors to separate companies having higher margins from those having a high turnover. In fact, it also focuses on the company’s leverage status. A lofty ROE could be due to the overuse of debt. If this is the case, the strength of a company can be uncertain if it has a high debt load.
So, an investor relying solely on basic ROE may be confused if he or she has to judge between two stocks of an equal ratio. This is where DuPont analysis wins while finding out 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.
• 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.You can see the complete list of today’s Zacks #1 Rank stocks here.
• 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 all six stocks that made it through the screen:
MEDIFAST INC (MED): This Zacks Rank #2 company is a leading manufacturer and distributor of clinically proven healthy living products and programs.
Systemax Inc. (SYX): The company is a direct marketer of brand name and private-label products, including personal desktop computers, notebook computers, computer-related products and industrial products, in North America and Europe. The stock carries a Zacks Rank #2.
USANA Health Sciences Inc. (USNA): The company develops and manufactures high-quality nutritional, personal care and weight-management products. The stock has a Zacks Rank #2.
Universal Forest Products Inc. (UFPI):The company supplies wood, wood composite and other products in retail, industrial and construction markets. The stock carries a Zacks Rank #2.
AllianceBernstein Holding L.P. (AB): The Zacks Rank #2 companyprovides diversified investment management services, primarily to pension funds, endowments, foreign financial institutions and individual investors.
Landstar System Inc. LSTR: The Zacks Rank #2 company is an asset-light provider of integrated transportation management solutions.
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.
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
Systemax Inc. (SYX): Free Stock Analysis Report
AllianceBernstein Holding L.P. (AB): Free Stock Analysis Report
Universal Forest Products, Inc. (UFPI): Free Stock Analysis Report
USANA Health Sciences, Inc. (USNA): Free Stock Analysis Report
Landstar System, Inc. (LSTR): Free Stock Analysis Report
MEDIFAST INC (MED): Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.