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 that.
So in this series we let the DuPont do the work. Let's see what the formula can tell us about Frontline
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 doesn't need to invest as much 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 shippers?
Return on Equity
|Nordic American Tankers||(7.0%)||(74.5%)||0.08||1.14|
|Ship Finance International||16.1%||45.8%||0.10||3.60|
Source: S&P's Capital IQ.
Only Ship Finance international
Many of these companies are suffering from a tough economic environment for dry bulk shipping due to shrinking demand, an oversupply of cargo shippers, and an inability to gain access to credit. As an oil shipper, Frontline is also suffering from a reduction in oil production due to civil conflict in Northern Africa and the Middle East. In addition, increased oil exploration and new oil discoveries in the U.S. have led to a reduced demand to ship oil from other places, which affects Frontline, along with Ship Finance International and Nordic American Tankers
Some of these companies are more insulated from the industry crisis than others. DryShips
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 just the earnings headlines.
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