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The DuPont Equation, Find Stocks With Strong Profitability

Kapitall often screens companies for strong profitability by performing a DuPont analysis on the names. Here's why:

DuPont analysis, also known as "DuPont identity" was started by the DuPont Corporation in the 1920s. Here, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). If the ROE is unsatisfactory, the DuPont analysis helps target the part of the business that is underperforming.

DuPont analyzes return on equity (ROE, or net income/equity) profitability by breaking ROE up into three components:

ROE

= (Net Profit/Equity)

= (Net Profit/Sales)*(Sales/Assets)*(Assets/Equity)

= (Net Profit Margin)*(Asset Turnover)*(Leverage Ratio)

It therefore focuses on companies with the following positive 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.