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 Las Vegas Sands
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
|Las Vegas Sands||20.8%||16.6%||0.89||1.16|
Melco Crown Entertainment
Source: S&P Capital IQ.
MGM Resorts' return on equity dwarfs those of the other companies, largely because of its very high net margins and a leverage ratio far higher than any of the others. Its asset turnover, on the other hand, is much lower. Melco Crown comes out on the bottom, with net margins far below that offered by the other listed companies and the lowest leverage ratio. Its asset turnover, on the other hand, is the second highest.
Las Vegas Sands, Wynn Resorts, and Melco Crown have profited from expansion into the Asian market, especially Macau. Their main obstacle relates to regulation of areas to which they hope to expand. For example, further growth in Singapore is prohibited until 2017. They also face slowing economic growth in the Asian markets they are targeting.
While MGM also has a presence in Macau, the majority of its business is in Las Vegas, and the gaming business in that area has been tough. Also, MGM has a debt that is close to double its annual revenue, which puts it in a difficult position even after the gaming business in Las Vegas recovers. However, there has been talk about the possibility that online poker could become legal in the U.S., in which case MGM said it would join Boyd Gaming
Using the DuPont Formula can often give you some insight into how a company is competing against its 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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Jim Royal, Ph.D., owns no shares in any company mentioned. 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.