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 Buffalo Wild Wings
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.
- 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
|Buffalo Wild Wings||17.5%||6.4%||1.79||1.52|
|Jack in the Box||13.0%||2.8%||1.56||3.02|
Source: S&P Capital IQ
While the restaurant industry as a whole has suffered from increases in the price of raw ingredients due to the rise in crop prices, Buffalo Wild Wings has the advantage of relying heavily on chicken, which has recently been at low prices due to oversupply problems in that area. This gives it an advantage over other restaurants like McDonald's, Domino's, and Papa John's, which rely more heavily on the higher priced raw ingredients.
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 McDonald's. The Motley Fool owns shares of Panera Bread, Domino's Pizza, Buffalo Wild Wings, and Papa John's International. Motley Fool newsletter services have recommended buying shares of McDonald's, Buffalo Wild Wings, and Panera Bread. Motley Fool newsletter services have recommended writing covered calls on Buffalo Wild Wings. 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.