There is always more to a company’s story than the bottom line. Although the bottom line, or net income, is the headline number that analysts watch and journalists report, companies can earn these profits in different ways - some more preferred than others. This is why it is always a good idea to study the source of profits for a company.
One way to analyze sources of profitability is with the DuPont analysis of return on equity (ROE) profitability.
ROE can be broken up into three components such that increases in ROE can be attributed to those components.
= (Net Profit/Equity)
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
= (Net Profit margin)*(Asset turnover)*(Leverage ratio)
Analyzing the sources of returns for a company, we can focus on companies with the following 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 passing all requirements are thus experiencing increasing profits due to operations and not to increased use of leverage.
To illustrate this analysis, we ran DuPont on stocks rallying above their 20-day, 50-day, and 200-day moving averages while undervalued to earnings growth (with PEG below 1).
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned below. Analyst ratings sourced from Zacks Investment Research.
We also created a price-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.
Click to enlarge
Do you think these companies have strong profitability? Use this list as a starting point for your own analysis.
List sorted by market cap.
1. Triumph Group, Inc. (TGI): Aerospace/Defense Products and Services Industry. Market cap of $2.39B. PEG at 0.85. Price is currently 2.29% above its 20-Day SMA, 0.88% above its 50-Day SMA, and 9.13% above its 200-Day SMA. MRQ Net Profit Margin increased to 5.94% from 2.79%, Sales/Assets increased to 0.19 from 0.09, while Assets/Equity decreased to 2.62 from 3.28. The stock is a short squeeze candidate, with a short float at 8.6% (equivalent to 6.21 days of average volume). The stock has gained 46.26% over the last year.
2. ProAssurance Corporation (PRA): Property and Casualty Insurance Industry. Market cap of $2.15B. PEG at 0.64. Price is currently 1.63% above its 20-Day SMA, 0.64% above its 50-Day SMA, and 9.20% above its 200-Day SMA. MRQ Net Profit Margin increased to 31.52% from 25.0%, Sales/Assets increased to 0.04 from 0.03, while Assets/Equity decreased to 2.51 from 2.64. The stock has gained 34.64% over the last year.
3. MasTec, Inc. (MTZ): Heavy Construction Industry. Market cap of $1.62B. PEG at 0.76. Price is currently 5.61% above its 20-Day SMA, 2.17% above its 50-Day SMA, and 9.93% above its 200-Day SMA. MRQ Net Profit Margin increased to 5.92% from 2.95%, Sales/Assets increased to 0.38 from 0.36, while Assets/Equity decreased to 2.38 from 2.47. Might be undervalued at current levels, with a PEG ratio at 0.76, and P/FCF ratio at 11. The stock is a short squeeze candidate, with a short float at 7.96% (equivalent to 5.99 days of average volume). The stock has performed poorly over the last month, losing 13.7%.
*Accounting data sourced from Google Finance, all other data sourced from Finviz.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.