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 Boston Scientific
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
Source: S&P's Capital IQ.
Boston Scientific has the next-highest ROE, at less than 4%. Its net margins are less than 6%, which is more than 3% lower than Hologic's and its asset turnover is not much higher than Hologic's. However, its leverage ratio is second only to Hologic. AngioDynamics
Boston Scientific is a producer of medical devices, and competes with companies like Abbott Labs, St. Jude Medical, and Medtronic. Its offerings include a wide range of products, including stents, heart defibrillators, and catheters. Boston Scientific recently brought on Michael Mahoney, the former chairman of Johnson & Johnson's medical device group, as its CEO. However, due to a non-compete clause, Mahoney will not be able to serve as the company's CEO until late 2012. Therefore, they will have to use an interim CEO for a one-year period, making it harder for them to enjoy a smooth transition. Also, while Boston Scientific may benefit from Johnson & Johnson's decision to stop selling drug-eluting stents, the company still faces competition from Medtronic and Abbott Labs in selling these stents.
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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Jim Royal, Ph.D., owns shares in J&J. The Motley Fool owns shares of Johnson & Johnson, Abbott Laboratories, St. Jude Medical, and Medtronic. Motley Fool newsletter services have recommended buying shares of Abbott Laboratories and Johnson & Johnson and creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.