Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

How Do These Steelmakers Really Boost Their Returns?

By Jim Royal - Updated Apr 6, 2017 at 9:48PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Break it down with the DuPont formula.

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.

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.

Let's see what the DuPont formula can tell us about ArcelorMittal (NYSE: MT) and a few of its sector and industry peers:

Company

Return on Equity

Net Margin

Asset Turnover

Leverage Ratio

ArcelorMittal

5.2%

4.0%

0.65

1.98

POSCO (NYSE: PKX)

12.2%

6.9%

1.05

1.75

Nucor (NYSE: NUE)

4.6%

1.5%

1.25

1.81

U.S. Steel (NYSE: X)

(9.7%)

(2.2%)

1.18

3.67

Source: Capital IQ, a division of Standard & Poor's.

The returns on equity here are lackluster, despite the use of leverage. POSCO has the highest ROE of its competitors, with net margins far higher than its competitors'. U.S. Steel has the lowest ROE, with negative net margins and a very high leverage ratio, which exacerbates the negative numbers. ArcelorMittal's low asset turnover help lead to its low ROE, and Nucor's return is hurt by its low margin, since asset turnover and leverage sit among peers' here.

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. If you'd like to add these companies to your watchlist, or set up a new one, just click here.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

ArcelorMittal Stock Quote
ArcelorMittal
MT
$28.17 (2.10%) $0.58
POSCO Stock Quote
POSCO
PKX
$61.02 (2.61%) $1.55
Nucor Corporation Stock Quote
Nucor Corporation
NUE
$110.24 (-0.23%) $0.26
United States Steel Corporation Stock Quote
United States Steel Corporation
X
$22.65 (0.35%) $0.08

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
624%
 
S&P 500 Returns
140%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/06/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.