How Does Exelon Boost Its Returns?

As investors, we need to understand how our companies truly make their money. A neat trick developed for just that purpose -- the DuPont Formula -- can help us do so.

So in this series we let the DuPont Formula do the work. Let's see what the formula can tell us about Exelon (NYSE: EXC  ) and a few of its peers.

The DuPont Formula can give you a better grasp on exactly where your company is producing its profit, and where it might have a competitive advantage. Named after the company where it was pioneered, the formula breaks down return on equity into three components:

Return on equity = net margin x asset turnover x leverage ratio

What makes each of these components important?

  • High net margins show that a company can get customers to pay more for its products. Luxury-goods companies provide a great example here.
  • High asset turnover indicates that a company needs to invest less of its capital, since it uses its assets more efficiently to generate sales. Service industries, for instance, often lack big capital investments.
  • Finally, the leverage ratio shows how much the company is relying on liabilities to create its profits.

Generally, the higher these numbers, the better. That said, too much debt can sink a company, so beware of companies with very high leverage ratios.

So what does DuPont say about these four companies?

Company

Return on Equity

Net Margin

Asset Turnover

Leverage Ratio

Exelon 17.9% 13.2% 0.35 3.84
Duke Energy (NYSE: DUK  ) 7.5% 11.7% 0.24 2.67
American Electric Power (NYSE: AEP  ) 10.6% 9.9% 0.29 3.62
National Grid (NYSE: NGG  ) 28.8% 15.4% 0.31 6.07

Source: S&P Capital IQ.

National Grid has by far the highest returns on equity of these companies, and you can see the key differences. While its asset turnover is close to that of the other companies, it has the highest net margins, and its leverage ratio is by far larger than the others'. Exelon has the next highest ROE, with the highest asset turnover and the second highest net margins and leverage ratio. American Electric Power has returns on equity that are more than 7 percentage points lower than Exelon's, largely because of a much lower margin. Duke Energy's returns on equity are the lowest, largely because of low asset turnover and leverage.

Exelon has managed to keep its share prices relatively steady during the economic crisis. The company's focus on nuclear energy in electricity generation has put it in a strong position to benefit from the government's attempt to find alternatives to fossil-fuel energy. While the earthquake in Japan has raised concerns about nuclear power, nuclear still generates 20% of power in the U.S., and until we find better alternatives it is unlikely that nuclear energy will be abandoned.

Nevertheless, the concerns about nuclear energy have affected several companies with a stake in nuclear power. NRG (NYSE: NRG  ) , for example, has written off its investment in its South Texas Nuclear development project, which cost the company nearly $500 million. Uranium miners Cameco and Uranium Energy have also seen their share prices fall.

Using the DuPont Formula can often give you some insight into how a company is competing against peers and what type of strategy it's using to juice return on equity. To find more successful investments, dig deeper than the earnings headlines.

Add these companies to your Watchlist:

Jim Royal, Ph.D., owns no shares in any company mentioned. Motley Fool newsletter services have recommended buying shares of National Grid and Exelon and creating a write covered strangle position in Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 1824574, ~/Articles/ArticleHandler.aspx, 4/21/2014 6:28:49 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement