A company’s profitability can come from more than one source, and some are preferred over others. This is why an analysis beyond the top and bottom-line numbers is important when choosing stocks.
One way to analyze sources of profitability is with 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 from the retail industry.
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.
Do you think these companies are operating well? Use this list as a starting-off point for your own analysis.
List sorted by market cap.
1. Nordstrom Inc. (JWN): A fashion specialty retailer, offers apparel, shoes, cosmetics, and accessories for women, men, and children in the United States. Market cap of $9.82B. MRQ Net Profit Margin increased to 6.23% from 5.81% year-over-year, Sales/Assets increased to 0.36 from 0.34, while Assets/Equity decreased to 3.86 from 4.03. The stock has had a good month, gaining 22.85%.
2. Dollar Tree, Inc. (DLTR): Operates discount variety stores in the United States and Canada. Market cap of $9.27B. MRQ Net Profit Margin increased to 6.15% from 5.66% year-over-year, Sales/Assets increased to 0.62 from 0.61, while Assets/Equity decreased to 1.56 from 1.63. The stock has had a good month, gaining 17%.
3. Abercrombie & Fitch Co. (ANF): Operates as a specialty retailer of casual apparel for men, women, and kids. Market cap of $5.71B. MRQ Net Profit Margin increased to 3.49% from 2.61% year-over-year, Sales/Assets increased to 0.31 from 0.26, while Assets/Equity decreased to 1.55 from 1.57. The stock has had a good month, gaining 16.39%.
4. Jos. A Bank Clothiers Inc. (JOSB): Design, retails, and direct-markets men's tailored and casual clothing and accessories. Market cap of $1.38B. MRQ Net Profit Margin increased to 8.91% from 8.75% year-over-year, Sales/Assets increased to 0.32 from 0.32, while Assets/Equity decreased to 1.36 from 1.38. The stock is a short squeeze candidate, with a short float at 19.11% (equivalent to 13.84 days of average volume). The stock has had a good month, gaining 19.31%.
5. Iconix Brand Group, Inc. (ICON): Operates as a brand management company that engages in licensing, marketing, and providing trend direction for a portfolio of owned consumer brands. Market cap of $1.23B. MRQ Net Profit Margin increased to 46.52% from 32.29% year-over-year, Sales/Assets increased to 0.0418 from 0.0404, while Assets/Equity decreased to 1.87 from 1.93. The stock is a short squeeze candidate, with a short float at 12.3% (equivalent to 11.77 days of average volume). It's been a rough couple of days for the stock, losing 8.13% over the last week.
*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.