One of the most important things to check in a company analysis is their sources of profitability. It's easy to look at changes in profit margins over time, but finding out where those changes come from is even more telling.
This can be done using DuPont analysis, which breaks down return on equity (ROE) profitability into three sources:
=(Net Profit margin)*(Asset turnover)*(Leverage ratio)
Because increases in net margin and asset turnover are considered positive things, DuPont focuses on companies with these 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)
Those companies that pass DuPont are seeing positive trends in the sources of their increasing profitability, which adds further weight to the idea that the names are profitable.
We ran a DuPont analysis on the retail sector, and also screened for retailers that appear undervalued relative to their free cash flows, with P/FCF below 15. P/FCF at 15 is generally known to be a fair level for most companies, therefore companies with lower ratios may be undervalued.
Interactive Chart: Press Play to compare changes in market cap over the last two years for the stocks mentioned below. Analyst ratings sourced from Zacks Investment Research.
Do you think these retailers have strong profitability? Use this list as a starting point for your own analysis.
List sorted by P/FCF, which may indicate how undervalued the stock is relative to free cash flows.
1. Saks Incorporated (SKS): Operates fashion retail stores in the United States. Market cap at $1.68B. Price at $11.14. P/FCF at 8.85. MRQ net profit margin at 4.% vs. 2.88% y/y. MRQ sales/assets at 0.435 vs. 0.404 y/y. MRQ assets/equity at 1.764 vs. 1.842 y/y.
2. Staples, Inc. (SPLS): Operates as an office products company. Market cap at $10.88B. Price at $15.86. P/FCF at 11.89. MRQ net profit margin at 4.39% vs. 4.28% y/y. MRQ sales/assets at 0.481 vs. 0.461 y/y. MRQ assets/equity at 1.915 vs. 2.003 y/y.
3. Ascena retail group inc. (ASNA): Operates as a specialty retailer of apparel for women and tween girls in the United States and Puerto Rico. Market cap at $3.25B. Price at $21.42. P/FCF at 14.18. MRQ net profit margin at 7.39% vs. 5.65% y/y. MRQ sales/assets at 0.449 vs. 0.437 y/y. MRQ assets/equity at 1.528 vs. 1.573 y/y.
*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.