As U.S.-China trade tensions have escalated this month and market volatility has edged higher, investors are probably hunting for some quality picks to stay unscathed by the trade-war-inflicted selloff. In this vein, betting on stocks that are rich in return on equity (ROE) can be rewarding.
ROE is one of the most coveted metrics among investors in search of profit-generating stocks. But ROE doesn’t 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 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 10 stocks that made it through the screen:
Shoe Carnival, Inc. (SCVL): This Zacks Rank #2 company is one of the nation's largest family footwear retailers. The stock belongs to a top-ranked Zacks industry (top 34%). You can see the complete list of today’s Zacks #1 Rank stocks here.
Ulta Beauty Inc. (ULTA): The company is a beauty retailer and salon service provider primarily in the United States. The stock carries a Zacks Rank #2. It comes from a top-ranked Zacks industry (top 26%).
Amedisys Inc. (AMED): The company is a leading provider of health care in the home with a vision of becoming a premiere solution for patients. The stock hails from a top-ranked Zacks industry (top 40%) and has a Zacks Rank #2.
NVR, Inc. (NVR):The company operates in two business segments: homebuilding and mortgage banking. The stock carries a Zacks Rank #1 and belongs to a top-ranked Zacks sector (top 20%).
EMCOR Group Inc. (EME): This is a provider of critical infrastructure systems. It has a Zacks Rank #1 and it belongs to a top-ranked Zacks industry (top 15%).
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.
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
EMCOR Group, Inc. (EME) : Free Stock Analysis Report
NVR, Inc. (NVR) : Free Stock Analysis Report
Amedisys, Inc. (AMED) : Free Stock Analysis Report
Shoe Carnival, Inc. (SCVL) : Free Stock Analysis Report
Ulta Beauty Inc. (ULTA) : Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research