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
• 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 clean energy stocks, companies that either use or develop sources of clean energy.
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 have strong profitability? Use this list as a starting point for your own analysis.
List sorted by increase in ROE.
1. General Electric Company (GE): Operates as a technology, service, and finance company worldwide. Market cap of $160.89B. 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 is currently stuck in a downtrend, trading 7.78% below its SMA20, 6.35% below its SMA50, and 16.55% below its SMA200. It's been a rough couple of days for the stock, losing 5.34% over the last week.
2. Calgon Carbon Corporation (CCC): Provides services, products, and solutions for purifying water, air, food, beverage, and industrial process streams in the United States and internationally. Market cap of $800.18M. MRQ Net Profit Margin increased to 10.11% from 8.0% year-over-year, Sales/Assets increased to 0.27 from 0.25, while Assets/Equity decreased to 1.38 from 1.48. The stock is a short squeeze candidate, with a short float at 6.29% (equivalent to 7.99 days of average volume). The stock has lost 2.62% over the last year.
3. Cabot Corp. (CBT): Provides specialty chemicals and performance materials worldwide. Market cap of $1.99B. MRQ Net Profit Margin increased to 5.89% from 5.0% year-over-year, Sales/Assets increased to 0.26 from 0.24, while Assets/Equity decreased to 2.12 from 2.22. It's been a rough couple of days for the stock, losing 5.26% over the last week. The stock has had a good month, gaining 10.76%.
*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.