The returns on equity earned by these companies span the range from mediocre to stellar. Here are the median ROEs for these companies since 1996 - 97, according to StockPup.com:
Macy’s is below average for the S&P 500, Kohl’s and Target are solid performers, while TJX results are phenomenal. Not surprisingly, TJX shareholders saw their shares appreciate from $4.70 in 1997 (adjusted for dividends) to $55.50 today – a compounded annual growth rate (“CAGR”) of 19%, while Macy’s shareholders watched their shares slog from $16.43 to $26.32 over the same period – a CAGR of only 3.4%.
One of the key questions for an investor is what kind of performance can be expected from these companies going forward. History, seen through the prism of DuPont Analysis, offers some clues. In its most common form, DuPont equation is a decomposition of ROE into 3 factors:
ROE = (Net Margin) * (Asset Turnover) * (Asset to Equity Ratio)Net Margin indicates operating efficiency, Asset Turnover measures the total asset use efficiency, and the Asset to Equity Ratio is a measure of financial leverage.
Let’s start with TJX, and look at its return on equity, and its components:
Let’s add Kohl’s (KSS) to the picture. The ROE at KSS is roughly similar to TGT – a bit lower. The Asset Turnover is also similar to TGT. However, we see a consistently higher Net Margin and significantly lower leverage, as measured by the Asset to Equity Ratio. The lesson is that Kohl’s is operationally more efficient than TGT and even TJX, and chooses a much safer financial structure, with over a 60% of its Assets coming from Equity, compared to less than 40% at TGT or TJX. This choice of a safer balance sheet reduces Kohl’s earning power, but makes it more attractive to investors seeking safety.
For investors looking to build a stock portfolio of strong long-term performers, a high Return on Equity is one of the most desirable characteristics in a company. DuPont analysis provides a way to study the ROE, and understand the key factors that define this metric. In the case of the four retailers we examined, DuPont analysis sheds light on the trade-offs between business performance and balance sheet risk. It also points at further research questions, e.g. “why are Asset Turnovers different among these companies”, that an investor would want answered to choose among these companies.