What You Need to Know About Advance Auto Parts' Return on Equity

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Way back in the 1920s, DuPont Corp. gave us a useful way to measure a company's performance. The DuPont analysis was used to gauge a company's performance through its return on equity, or ROE, which is important for investors because it shows how profitable a company is for its shareholders. DuPont breaks down ROE into three parts:

ROE = net profit margin x asset turnover ratio x equity multiplier ratio

Net profit margin: This component gives us an understanding of how effectively a company can convert its revenues into earnings. Net margins vary across industries; what is high in one industry may not be in another.

Asset turnover ratio: This tells us how efficiently a firm converts its available assets to generate revenue. Companies with low profit margins generally tend to have higher asset turnover ratios.

Equity multiplier ratio: This tells us how much liability a company uses to finance its assets and what portion of ROE is driven by liability. Thus, a company could assume more debt to increase its ROE.

Significance of DuPont
The DuPont formula gives us a better understanding of a company's efficiency. Investors should know exactly where their money is coming from, and that's where the DuPont ROE analysis comes in.

Let's use the DuPont analysis to derive aftermarket retailer Advance Auto Parts' (NYS: AAP) ROE.

Metric

LTM 2011

LTM 2010

Net Margin5.92%5.43%
Asset Turnover1.751.77
Equity Multiplier3.792.74
Return on Equity39.2%26.3%

Source: Capital IQ, a division of Standard & Poor's; NM = not meaningful.

Advance's net margin has increased in the past twelve months, while its asset turnover ratio has declined slightly during this period. The equity multiplier has shown the highest percentage change. The company's assets increased to $3.6 billion, up 8% from a year ago, while its equity has fallen to $764.3 million, down 28%. At the same time, the company has assumed more debt. Its total debt has gone up to $566.4 million, up nearly 57% from a year ago.

Let's now see what factors have affected ROE at Advance's peers.

Company

Net Margin

Asset Turnover

Equity Multiplier

ROE

AutoZone

10.37%

1.39

(7.17)

NM

O'Reilly (NAS: ORLY)

8.19%

1.09

1.69

15.1%

Genuine Parts (NYS: GPC)

4.44%

2.18

1.95

18.9%

Pep Boys (NYS: PBY)

1.86%

1.28

3.28

7.9%

Source: Capital IQ, a division of Standard & Poor's; NM = not meaningful.

AutoZone has the highest net margin in the list, but has a negative equity multiplier ratio since the company runs with negative equity. Genuine Parts has the highest asset turnover ratio and a high ROE of 18.9%.

We see that Advance tops the list with an ROE of 39.2%. However, this has resulted from a high equity multiplier as the company has taken on more debt. The company has added nearly 130 new stores in the last year or so. Plus, it is investing in its commercial and e-commerce businesses which should deliver growth in the long run.

The Foolish bottom line
As the economic recovery has been slow, aftermarket retailers have profited as consumers have preferred to maintain their old cars rather than purchase new ones. Thus, Advance has reaped the benefits of a troubled US economy. With the economic expansion still lacking vigor, we can expect Advance to keep profiting in the near term.

Now that we've broken down Advance's ROE using the DuPont analysis, we can see what is driving its ROE. This will give its investors, or those considering investing in the stock, a better idea of what is powering returns. To stay up-to-speed on all the top news and analysis on Advance Auto Parts -- click here to add it to your stock Watchlist.

At the time this article was published Shubh Datta doesn't own any shares in the companies mentioned above.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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