How Does Activision Blizzard Really Juice Its Return on Equity?
As investors, we need to understand how our companies truly make their money. A neat trick developed for just that purpose -- the DuPont Formula -- can help us do so.
The DuPont Formula can give you a better grasp on exactly where your company is producing its profit, and where it might have a competitive advantage. Named after the company where it was pioneered, the formula breaks down return on equity into three components:
Return on equity = net margin x asset turnover x leverage ratio
What makes each of these components important?
High net margins show that a company can get customers to pay more for its products. Luxury-goods companies provide a great example, here.
High asset turnover indicates that a company needs to invest less of its capital, since it uses its assets more efficiently to generate sales. Service industries, for instance, often lack big capital investments.
Finally, the leverage ratio shows how much the company is relying on liabilities to create its profits.
Generally, the higher these numbers, the better. That said, too much debt can sink a company, so beware of companies with very high leverage ratios.
Let's see what the DuPont Formula can tell us about Activision Blizzard (NAS: ATVI) and a few of its sector and industry peers:
Company | Return on Equity | Net Margin | Asset Turnover | Leverage Ratio |
|---|---|---|---|---|
Activision Blizzard | 6.2% | 13.8% | 0.39 | 1.14 |
Electronic Arts (NAS: ERTS) | (5.5%) | (4%) | 0.88 | 1.56 |
Take-Two Interactive Software (NAS: TTWO) | 4.3% | 1.2% | 2.18 | 1.63 |
Sony (NYS: SNE) | (8.5%) | (4.3%) | 0.55 | 4.17 |
Source: Capital IQ, a division of Standard & Poor's.
Activision Blizzard puts up a solid net margin but it's return on equity leaves something to be desired, due to lower asset turnover and leverage than its peers. Electronic Arts does better in both these latter categories, but its negative net margin pulls ROE into the red. Take Two uses still more leverage and higher asset turnover, but its thin margin make ROE look anemic. And for Sony, even high leverage doesn't reverse its negative margin, pulling ROE in the negatives.
Using the DuPont formula can often give you some insight into how a company is competing against peers and what type of strategy it's using to juice return on equity. To find more successful investments, dig deeper than the earnings headlines. If you'd like to add these companies to your watchlist, or set up a new one, click on any of the following links:
Add Activision Blizzard to My Watchlist.
Add Take-Two Interactive Software to My Watchlist.
Add Sony to My Watchlist.
Add Electronic Arts to My Watchlist.
At the time thisarticle was published We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.Jim Royal, Ph.D.,owns shares in Activision Blizzard. The Motley Fool owns shares of Activision Blizzard and Take-Two. The Fool owns shares of and has written calls on Activision Blizzard.Motley Fool newsletter serviceshave recommended buying shares of Activision Blizzard and Take-Two.Motley Fool newsletter serviceshave recommended creating a synthetic long position in Activision Blizzard. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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