There are many ways to look at a company's profitability, but one of the most popular is a DuPont analysis of return on equity (ROE). Profits come from more than one source, and some are better than others. DuPont analysis measures the sources of profitability to find those companies with the strongest sources.
DuPont analyzes return on equity (or net income/equity) profitability by breaking ROE up into three components:
= (Net Profit/Equity)
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
= (Net Profit margin)*(Asset turnover)*(Leverage ratio)
It therefore focuses on companies with the following positive characteristics: Increasing ROE along with:
- Decreasing leverage, (i.e., decreasing Asset/Equity ratio)
- Improving asset use efficiency (i.e., increasing Sales/Assets ratio) and improving net profit margin (i.e., increasing Net Income/Sales ratio)
Companies with all of these characteristics are experiencing increasing profits due to operations and not to increased use of financial leverage.
To illustrate this, we ran DuPont analysis on outperforming stocks with quarterly performance over 20%.
Business section: Investing ideas
Below is the final list from this screen. These stocks have outperformed and have had strong sources of profitability, as measured by DuPont analysis.
Do you think these stocks will continue to outperform? (Click here to access free, interactive tools to analyze these ideas.)
1. ascena retail group
2. Phillips-Van Heusen
3. Ross Stores
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
Kapitall's Alexander Crawford does not own any of the shares mentioned above. Accounting data sourced from Google Finance, all other data sourced from Finviz.
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