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We performed a DuPont analysis on the Return on Equity (ROE) of about 130 large cap stocks, from which 12 companies arose with red-flag trends. We broke the ROE equation into three parts:

ROE

= (Net Profit/Equity)

= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)

= (Net Profit margin)*(Asset turnover)*(Leverage ratio)

All of the stocks mentioned below have seen rising ROE values during the recent quarter. But we wanted to analyze the sources of these returns, and narrowed down the original universe to only focus on companies with the following characteristics:

  • Increasing leverage, i.e. rising Asset/Equity ratio
  • Worsening asset use efficiency (i.e. declining Sales/Assets ratio) and/or worsening net profit margin (i.e. declining Net Income/Sales ratio)

Is this an excessive use of leverage? To provide perspective on investor sentiment, we'll also include data on short positions affecting these stocks. Full details below.

Accounting data from Google Finance, short float and performance data from Finviz.

click for expanded image

The list has been sorted by the increase in ROE. Note: All ratios compare the most recent quarter's values against last year's corresponding quarter.

1. The Coca-Cola Company (KO): Soft Drinks Industry. Market cap of $149.89B. Return on Equity increased from 6.22% to 18.61%. When analyzing the sources of return, Net Profit Margin increased from 20.55% to 54.99%. Sales/Assets decreased from 0.154 to 0.144, while Leverage ratio increased from 1.96 to 2.35 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 0.53%, which implies a short ratio of 1.31 days. The stock has gained 20.23% over the last year.

2. Baker Hughes Incorporated (BHI): Oil & Gas Equipment & Services Industry. Market cap of $30.55B. Return on Equity increased from 1.15% to 2.34%. When analyzing the sources of return, Net Profit Margin increased from 3.46% to 7.57%. Sales/Assets decreased from 0.212 to 0.193, while Leverage ratio increased from 1.57 to 1.60 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 2.26%, which implies a short ratio of 1.99 days. The stock has gained 48.9% over the last year.

3. Express Scripts Inc. (ESRX): Health Care Plans Industry. Market cap of $29.99B. Return on Equity increased from 5.97% to 9.36%. When analyzing the sources of return, Net Profit Margin decreased from 3.52% to 2.68%. Sales/Assets increased from 0.549 to 1.104, while Leverage ratio increased from 3.09 to 3.17 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 1.45%, which implies a short ratio of 2.45 days. The stock has gained 27.03% over the last year.

4. American Express Company (AXP): Credit Services Industry. Market cap of $54.81B. Return on Equity increased from 4.97% to 6.64%. When analyzing the sources of return, Net Profit Margin increased from 10.15% to 13.40%. Sales/Assets decreased from 0.056 to 0.054, while Leverage ratio increased from 8.69 to 9.19 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 1.13%, which implies a short ratio of 1.54 days. The stock has gained 19.03% over the last year.

5. Franklin Resources Inc. (BEN): Asset Management Industry. Market cap of $29.09B. Return on Equity increased from 4.98% to 6.16%. When analyzing the sources of return, Net Profit Margin increased from 25.82% to 29.47%. Sales/Assets decreased from 0.149 to 0.137, while Leverage ratio increased from 1.29 to 1.52 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 1.05%, which implies a short ratio of 1.36 days. The stock has gained 29.78% over the last year.

6. Colgate-Palmolive Co. (CL): Personal Products Industry. Market cap of $37.85B. Return on Equity increased from 20.25% to 23.33%. When analyzing the sources of return, Net Profit Margin increased from 15.46% to 15.69%. Sales/Assets decreased from 0.367 to 0.356, while Leverage ratio increased from 3.57 to 4.18 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 1.03%, which implies a short ratio of 1.7 days. The stock has lost -1.91% over the last year.

7. Wal-Mart Stores Inc. (WMT): Discount, Variety Stores Industry. Market cap of $197.26B. Return on Equity increased from 4.67% to 5.24%. When analyzing the sources of return, Net Profit Margin increased from 3.16% to 3.37%. Sales/Assets decreased from 0.576 to 0.546, while Leverage ratio increased from 2.56 to 2.85 (comparing the 3 months ending 2009-09-30 vs. the 3 months ending 2010-09-30). Short float at 1.61%, which implies a short ratio of 2.52 days. The stock has gained 5.25% over the last year.

8. Southern Copper Corp. (SCCO): Copper Industry. Market cap of $36.24B. Return on Equity increased from 8.55% to 9.42%. When analyzing the sources of return, Net Profit Margin increased from 27.13% to 29.03%. Sales/Assets decreased from 0.203 to 0.165, while Leverage ratio increased from 1.55 to 1.96 (comparing the 3 months ending 2009-10-31 vs. the 3 months ending 2010-10-31). Short float at 2.86%, which implies a short ratio of 2.79 days. The stock has gained 47.1% over the last year.

9. Hewlett-Packard Company (HPQ): Diversified Computer Systems Industry. Market cap of $105.84B. Return on Equity increased from 5.95% to 6.27%. When analyzing the sources of return, Net Profit Margin decreased from 7.84% to 7.63%. Sales/Assets decreased from 0.268 to 0.267, while Leverage ratio increased from 2.83 to 3.08 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 1.01%, which implies a short ratio of 1.27 days. The stock has lost -3.05% over the last year.

10. McDonald's Corp. (MCD): Restaurants Industry. Market cap of $80.43B. Return on Equity increased from 8.67% to 9.11%. When analyzing the sources of return, Net Profit Margin decreased from 20.37% to 19.99%. Sales/Assets increased from 0.198 to 0.199, while Leverage ratio increased from 2.15 to 2.29 (comparing the 3 months ending 2009-12-31 vs. the 3 months ending 2010-12-31). Short float at 0.45%, which implies a short ratio of 0.61 days. The stock has gained 21.38% over the last year.

11. Amgen Inc. (AMGN): Biotechnology Industry. Market cap of $49.36B. Return on Equity increased from 4.11% to 4.27%. When analyzing the sources of return, Net Profit Margin increased from 24.44% to 26.61%. Sales/Assets decreased from 0.096 to 0.088, while Leverage ratio increased from 1.75 to 1.82 (comparing the 3 months ending 2009-09-30 vs. the 3 months ending 2010-09-30). Short float at 1.46%, which implies a short ratio of 2.12 days. The stock has lost -8.51% over the last year.

12. Comcast Corporation (CMCSA): CATV Systems Industry. Market cap of $71.62B. Return on Equity increased from 2.24% to 2.30%. When analyzing the sources of return, Net Profit Margin decreased from 10.53% to 10.47%. Sales/Assets increased from 0.080 to 0.082, while Leverage ratio increased from 2.64 to 2.67 (comparing the 3 months ending 2009-10-31 vs. the 3 months ending 2010-10-31). Short float at 1.78%, which implies a short ratio of 3.21 days. The stock has gained 61.75% over the last year.

Source: Accounting Flags: 12 Large Caps With Rising Leverage Ratios