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The sources of a company’s profitability are just as important a consideration as whether a company is profitable in the first place. Because profitability, as measured by return on equity, can increase simply from increased use of leverage, it is important to check the sources of profitability changes to verify that they indicate improvements in operations.

With this consideration in mind, we performed a DuPont analysis of the sources of profitability for stocks on a rally, i.e. companies trading above their 20-day, 50-day, and 200-day moving averages. From this analysis, we found 10 companies that passed all requirements for positive results.

[Click all to enlarge]

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 for the recent quarter, year-over-year.

Then we wanted to analyze the sources of these returns, so we narrowed down the original universe to only focus on companies with the following characteristics:

  • Decreasing leverage, i.e. decreasing Asset/Equity ratio.
  • Improving asset use efficiency (i.e. declining Sales/Assets ratio) and improving net profit margin (i.e. declining Net Income/Sales ratio).

Companies passing all requirements are thus experiencing increasing profits due to operations and not to increased use of leverage.

We also created an equal weighted index of the stocks mentioned below, and monitored the performance of the list relative to the S&P 500 index over the last month. To access a complete analysis of this list's recent performance, click here.

Do you think these rallies will continue? Use this list as a starting-off point for your own analysis. List sorted by increase in quarterly ROE year-over-year.

1. Celanese Corp. (CE): Chemicals Industry. Market cap of $7.59B. The stock is currently 4.21% above its 20-day moving average, 11.58% above its 50-day MA, and 30.25% above its 200-day MA. Return on Equity increased from 2.44% to 12.50%. When analyzing the sources of return, Net Profit Margin increased from 1.01% to 8.94%. Sales/Assets increased from 0.1692 to 0.1843, while Assets/Equity decreased from 14.2892 to 7.5898 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11).

2. Liberty Capital Group (LCAPA): Entertainment Industry. Market cap of $7.35B. The stock is currently 9.97% above its 20-day moving average, 14.87% above its 50-day MA, and 40.74% above its 200-day MA. Return on Equity increased from 0.83% to 10.08%. When analyzing the sources of return, Net Profit Margin increased from 13.25% to 50.43%. Sales/Assets increased from 0.0186 to 0.0899, while Assets/Equity decreased from 3.3861 to 2.2247 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11).

3. International Paper Co. (IP): Paper & Paper Products Industry. Market cap of $13.89B. The stock is currently 5.35% above its 20-day moving average, 11.08% above its 50-day MA, and 23.27% above its 200-day MA. Return on Equity increased from -2.78% to 4.67%. When analyzing the sources of return, Net Profit Margin increased from -2.79% to 5.35%. Sales/Assets increased from 0.2310 to 0.2495, while Assets/Equity decreased from 4.3207 to 3.4966 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11). The stock offers a good dividend, and appears to have good liquidity to back it up--dividend yield at 3.31%, current ratio at 1.89, and quick ratio at 1.36. The stock has gained 40.2% over the last year.

4. Caterpillar Inc. (CAT): Farm & Construction Machinery Industry. Market cap of $71.14B. The stock is currently 1.87% above its 20-day moving average, 4.30% above its 50-day MA, and 25.91% above its 200-day MA. Return on Equity increased from 2.61% to 9.70%. When analyzing the sources of return, Net Profit Margin increased from 2.83% to 9.46%. Sales/Assets increased from 0.1400 to 0.1951, while Assets/Equity decreased from 6.5797 to 5.2567 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11). The stock has gained 81.45% over the last year.

5. Eastman Chemical Co. (EMN): Chemicals Industry. Market cap of $7.35B. The stock is currently 4.05% above its 20-day moving average, 7.03% above its 50-day MA, and 27.61% above its 200-day MA. Return on Equity increased from 6.44% to 12.11%. When analyzing the sources of return, Net Profit Margin increased from 7.37% to 12.51%. Sales/Assets increased from 0.2426 to 0.2926, while Assets/Equity decreased from 3.5997 to 3.3071 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11). The stock has gained 72.09% over the last year.

6. Atmel Corporation (ATML): Semiconductor Industry. Market cap of $6.81B. The stock is currently 6.14% above its 20-day moving average, 11.55% above its 50-day MA, and 39.15% above its 200-day MA. Return on Equity increased from 2.15% to 6.94%. When analyzing the sources of return, Net Profit Margin increased from 4.77% to 16.16%. Sales/Assets increased from 0.2483 to 0.2760, while Assets/Equity decreased from 1.8160 to 1.5559 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11). The stock has had a good month, gaining 12.21%.

7. Cephalon Inc. (CEPH): Biotechnology Industry. Market cap of $6.08B. The stock is currently 3.48% above its 20-day moving average, 18.13% above its 50-day MA, and 26.21% above its 200-day MA. Return on Equity increased from 4.65% to 7.14%. When analyzing the sources of return, Net Profit Margin increased from 18.53% to 28.33%. Sales/Assets increased from 0.1246 to 0.1390, while Assets/Equity decreased from 2.0137 to 1.8125 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11).

8. CBS Corporation (CBS): Broadcasting Industry. Market cap of $17.77B. The stock is currently 5.88% above its 20-day moving average, 7.91% above its 50-day MA, and 38.44% above its 200-day MA. Return on Equity increased from -0.29% to 2.07%. When analyzing the sources of return, Net Profit Margin increased from -0.74% to 5.75%. Sales/Assets increased from 0.1320 to 0.1331, while Assets/Equity decreased from 2.9577 to 2.6965 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11).

9. Estee Lauder Companies Inc. (EL): Personal Products Industry. Market cap of $19.36B. The stock is currently 3.14% above its 20-day moving average, 4.99% above its 50-day MA, and 27.89% above its 200-day MA. Return on Equity increased from 2.77% to 4.93%. When analyzing the sources of return, Net Profit Margin increased from 3.09% to 5.76%. Sales/Assets increased from 0.3210 to 0.3495, while Assets/Equity decreased from 2.7907 to 2.4504 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11). The stock has gained 69.21% over the last year.

10. Hologic Inc. (HOLX): Medical Appliances & Equipment Industry. Market cap of $5.83B. The stock is currently 1.79% above its 20-day moving average, 3.12% above its 50-day MA, and 23.02% above its 200-day MA. Return on Equity increased from 0.74% to 2.89%. When analyzing the sources of return, Net Profit Margin increased from 4.93% to 18.79%. Sales/Assets increased from 0.0728 to 0.0752, while Assets/Equity decreased from 2.0573 to 2.0439 (comparing 3 mo. ending 3/27/10 vs. 3 mo. ending 3/26/11). The stock has gained 40.96% over the last year.

DuPont data sourced from Google Finance; all other data sourced from Finviz.

Source: 10 Rallying Stocks With Healthy Sources of Profitability