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5 Stock Picks from Dissecting ROE the DuPont Way

As Warren Buffett once said the return that a company generates as compared to its equity is one of the most important factors for successful stock investments. But ROE doesn’t tell a complete story and an investor might get fooled by picking stocks based on this number. 

Here is why…

If you closely look at the components of ROE, you will be surprised to see that it can be high for the wrong reasons as well.

For example, a lofty ROE could be due to the overuse of debt. Thus, ROE can be misleading if the company has a high debt burden.

Here is where DuPont analysis comes in handy. It’s basically decomposing and examining ROE. And one of the ROE components – equity multiplier (explained below) – can help you judge how burdened the company is with debts.

So an investor looking at two stocks only from an ROE perspective will be impartial if the values are the same. However, DuPont analysis will help differentiating the stocks and finding the better one.

DuPont analysis is not very difficult, as the required numbers are available in the company’s income statement and balance sheet.

Here is how DuPont dissects ROE:

ROE = Net Income/Equity

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

ROE = Profit Margin * Asset Turnover Ratio * Equity Multiplier

However, looking at financial statements of individual companies can be a tedious task. Screening tools like Zacks Research Wizard can easily shortlist the stocks that look impressive with a DuPont analysis.

Screen Parameters

Profit Margin more than or equal to 5: As the name suggests, it is a measure of how profitably the business is running. Generally, it is the key contributor to ROE.

Asset Turnover Ratio more than or equal to 2: It allows an investor to assess management’s efficiency in using assets to drive sales.

Equity Multiplier between 1 and 3: It’s an indication of how much debt the company uses to finance its assets.

Zacks Rank less than or equal to 2 - Stocks with a Zacks Rank #1 (Strong Buy) or #2 (Buy) generally outperforming the market.

Current Price more than $5 – This screens out the low priced stocks. However, when looking for lower priced stocks, this criterion can be removed.

Stocks

Here are 5 of the 9 stocks that made it through this week's screen:

Philip Morris International, Inc. (PM)

Domino's Pizza, Inc. (DPZ)

H & M Hennes & Mauritz AB (HNNMY)

Sanderson Farms, Inc. (SAFM)

Thor Industries Inc. (THO)

Each of these picks has immense potential and the entire list is worth considering. You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

Click here to sign up for a free trial to the Research Wizard today.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at:

http://www.zacks.com/performance.

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THOR INDS INC (THO): Free Stock Analysis Report
 
SANDERSON FARMS (SAFM): Free Stock Analysis Report
 
HENNES&MAURIT (HNNMY): Free Stock Analysis Report
 
DOMINOS PIZZA (DPZ): Free Stock Analysis Report
 
PHILIP MORRIS (PM): Free Stock Analysis Report
 
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