With the global markets witnessing steep selloffs in the final days of February on the coronavirus scare, looking for quality stocks is a natural choice for investors. There are plenty of criteria or metrics that can lead investors to quality stocks. Among these return on equity (ROE) is one of the most coveted ones.
That said, we would like to note that the basic ROE calculation doesn’t always tell the complete story and an investor might get misled by picking stocks based on this number. Thus, taking a step beyond the basic ROE and analyzing it at an advanced level or applying the DuPont technique seems to be an intriguing idea.
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 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.
• 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 seven stocks that made it through the screen:
Calavo Growers Inc. CVGW: This Zacks Rank #1 company is a global avocado-industry leader and an expanding provider of value-added fresh food. The stock belongs to a favorable Zacks industry (placed at the top 16% of 250+ industries). You can see the complete list of today’s Zacks #1 Rank stocks here.
USANA Health Sciences Inc. USNA: The company develops and manufactures high-quality nutritional, personal care and weight management products. The stock carries a Zacks Rank #1. It comes from a favorable Zacks industry (top 39%).
AllianceBernstein Holding L.P. AB: The Zacks Rank #2 provider of diversified investment management services, primarily to pension funds, endowments, foreign financial institutions, and to individual investors, hails from a top-ranked Zacks industry (top 6%).
EMCOR Group Inc. EME: The provider of mechanical and electrical construction as well as industrial and energy infrastructure carries a Zacks Rank #2 and belongs to a favorable Zacks industry (top 41%).
Zynex Inc. ZYXI:This maker of medical devices for the electrotherapy, and stroke and spinal cord injury hails from a favorable Zacks industry (top 30%). The stock has a Zacks Rank #2.
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 material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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AllianceBernstein Holding L.P. (AB) : Free Stock Analysis Report
EMCOR Group, Inc. (EME) : Free Stock Analysis Report
Zynex Inc. (ZYXI) : Free Stock Analysis Report
USANA Health Sciences, Inc. (USNA) : Free Stock Analysis Report
Calavo Growers, Inc. (CVGW) : Free Stock Analysis Report
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