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.
So in this series we let the DuPont do the work. Let's see what the formula can tell us about Boston Scientific (NYS: BSX) and a few of its peers.
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.
So what does DuPont say about these four companies?
Return on Equity
Source: S&P's Capital IQ.
CR Bard (NYS: BCR) offers far higher returns on equity than the other listed companies, thanks to substantially better net margins and asset turnover, while using less leverage than its comparables. Hologic (NAS: HOLX) offers the next highest ROE, but its returns are less than half of those offered by CR Bard. While its net margins are only just over 2% lower than CR Bard's, its asset turnover is the lowest of the listed companies. However, it has the highest leverage ratio of the listed companies.
Boston Scientific has the next-highest ROE, at less than 4%. Its net margins are less than 6%, which is more than 3% lower than Hologic's and its asset turnover is not much higher than Hologic's. However, its leverage ratio is second only to Hologic. AngioDynamics (NAS: ANGO) has the lowest ROE of the listed companies, with net margins just over half of Boston Scientific's, which has the next lowest net margins. Its asset turnover is also not much better than the Hologic's and Boston Scientific's, but its leverage ratio is much lower than theirs.
Boston Scientific is a producer of medical devices, and competes with companies like Abbott Labs, St. Jude Medical, and Medtronic. Its offerings include a wide range of products, including stents, heart defibrillators, and catheters. Boston Scientific recently brought on Michael Mahoney, the former chairman of Johnson & Johnson's medical device group, as its CEO. However, due to a non-compete clause, Mahoney will not be able to serve as the company's CEO until late 2012. Therefore, they will have to use an interim CEO for a one-year period, making it harder for them to enjoy a smooth transition. Also, while Boston Scientific may benefit from Johnson & Johnson's decision to stop selling drug-eluting stents, the company still faces competition from Medtronic and Abbott Labs in selling these stents.
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.
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At the time thisarticle was published Jim Royal, Ph.D.,owns shares in J&J. The Motley Fool owns shares of Johnson & Johnson, Abbott Laboratories, St. Jude Medical, and Medtronic.Motley Fool newsletter serviceshave recommended buying shares of Abbott Laboratories and Johnson & Johnson and creating a diagonal call position in Johnson & Johnson. 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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