Company profitability is not as straightforward as it often appears to be. Although net income is the popular headline number that analysts follow during earnings season, companies can earn these profits in different ways, with some preferred over others. This is why it is important to also 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; and
- 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 tech sector currently outperforming the market, with greater than 20% return over the last quarter.
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 stocks with continue to outperform? Use this list as a starting-off point for your own analysis.
List sorted by change in ROE.
1. Zygo Corporation (ZIGO): Designs, develops and manufactures ultra-high-precision measurement solutions to enhance its customers' manufacturing yields; and optical sub-systems and components for original equipment manufacturers and end-user applications in the United States and internationally. Market cap of $276.27M. The stock has gained 50.68% over the past quarter. MRQ Net Profit Margin increased to 14.71% from 8.77% year-over-year, Sales/Assets increased to 0.27 from 0.24, while Assets/Equity decreased to 1.23 from 1.25. The stock has had a couple of great days, gaining 5.39% over the last week.
2. Jabil Circuit Inc. (JBL): Provides electronic manufacturing services and solutions in the Americas, Europe, and Asia. Market cap of $4.22B. The stock has gained 25.28% over the past quarter. MRQ Net Profit Margin increased to 2.67% from 1.52% year-over-year, Sales/Assets increased to 0.6065 from 0.6063, while Assets/Equity decreased to 3.78 from 4.04. Might be undervalued at current levels, with a PEG ratio at 0.94, and P/FCF ratio at 13.67. The stock has gained 42.95% over the last year.
3. Raven Industries Inc. (RAVN): Manufactures products for industrial, agricultural, construction, and military/aerospace markets in North America. Market cap of $1.06B. The stock has gained 22.15% over the past quarter. MRQ Net Profit Margin increased to 13.79% from 11.41% year-over-year, Sales/Assets increased to 0.43 from 0.38, while Assets/Equity decreased to 1.29 from 1.29. It's been a rough couple of days for the stock, losing 6.24% over the last week.
4. OSI Systems, Inc. (OSIS): Designs, manufactures, and sells specialized electronic systems and components for applications in homeland security, healthcare, defense, and aerospace markets worldwide. Market cap of $903.90M. The stock has gained 26.79% over the past quarter. MRQ Net Profit Margin increased to 2.95% from 2.64% year-over-year, Sales/Assets increased to 0.27 from 0.25, while Assets/Equity decreased to 1.54 from 1.56. The stock has had a good month, gaining 14.23%.
Accounting data sourced from Google Finance; all other data sourced from Finviz.