There is always more to a company’s story than its 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 sources of profits for a company.
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 the 30 stocks of the Dow Jones Industrial Average.
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 increase in ROE.
1. General Electric Co. (NYSE:GE): Operates as a technology, service and finance company worldwide. Market cap of $172.26B. MRQ Net Profit Margin increased to 9.12% from 5.81% year-over-year, Sales/Assets increased to 0.0479 from 0.0466, while Assets/Equity decreased to 5.93 from 6.57. The stock has gained 4.5% over the last year.
2. United Technologies Corp. (NYSE:UTX): Provides technology products and services to the building systems and aerospace industries worldwide. Market cap of $69.69B. MRQ Net Profit Margin increased to 8.94% from 8.80% year-over-year, Sales/Assets increased to 0.24 from 0.22, while Assets/Equity decreased to 2.74 from 2.85. The stock has had a good month, gaining 10.6%.
3. Caterpillar Inc. (NYSE:CAT): Manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide. Market cap of $60.69B. MRQ Net Profit Margin increased to 7.26% from 7.11% year-over-year, Sales/Assets increased to 0.20 from 0.18, while Assets/Equity decreased to 5.49 from 6.27. The stock has had a good month, gaining 30.22%.
*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.