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 do the work. Let's see what the formula can tell us about Intel
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?
Return on Equity
Advanced Micro Devices
Source: S&P Capital IQ.
All of these companies have extremely high ROEs, with three of them offering returns in the 20% range, and Advanced Micro Devices offering returns near 90%. Intel has the highest net margin of its industry peers, but the lowest asset turnover -- and it doesn't have to rely on a high leverage ratio. Advanced Micro Devices largely achieves its high ROE through an extremely high leverage ratio and high asset turnover.
Intel is known for producing processors for PCs, but it has recently attempted to create and market processors for mobile devices. However, this may not be able to help Intel's value unless it can catch up with competitors like Broadcom
However, while Intel may have difficulty growing into new computer-based markets, its traditional PC business should be able to continue producing high profits (that can support its high dividend) for the foreseeable future.
Intel's 3.4% dividend yield towers over the competition, with Applied Materials offering 3%, Texas Instruments offering 2.3%, and Advanced Micro Devices offering no dividend. However, the stock has recently shown some volatility in its price.
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.
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