The Stock Market Is Not A Bracket

March Madness got rocking today and is off to a splash early. One of the most exciting sporting events of the year didn’t go on last year due to the early stages of the pandemic, and is still not going on normally a year later with both the Men’s and Women’s tournaments in a bubble. Certain stocks to watch during the tournament would be, Capital One ($COF), Draftkings ($DKNG), and ViacomCBS ($VIAC) for advertisements, gambling, and television revenue purposes, respectively.

The reason for this article is to stress the importance of doing proper due diligence when you are investing. You cannot just pick stocks how you pick a bracket. Lines such as “My friend said this is a lock,” and “There’s no way this doesn’t work out.” are phrases you will always regret. Investing money into a stock should not be done lightly, proper research is necessary. One effective way to measure performance of a company is through the Du Pont Analysis. In this analysis, a company’s Net Profit Margin, Total Asset Turnover, and Equity Multiplier are all analyzed to find how the company is making its money. Respectively, each figure measures the terms profit, efficiency, and leverage used in order to show the company’s return on equity. An example of company XYZ would be:

5.0% Net Profit Margin X 1.0 Total Asset Turnover X 5.0 Equity Multiplier =

25% Return On Equity

This company had a very good profit margin, which is there ratio of revenues with a removal of their costs. Their total asset turnover was fairly standard at 1.0 which is a ratio of their revenue to their total assets. Lastly their equity multiplier represents the total assets divided by the total equity, and is an indicator of how the company leverages their debt, with a higher number showing greater risk. Based off these given figures of XYZ, their risky debt usage is not an alarming number, but it is something to take note of. Due to the total asset turnover being fairly standard, their ability to achieve a substantial 25% on their equity is quite remarkable, and if they can bring down the equity multiplier in the future while maintaining the return on equity, the company could reach a new level.

It is important to take note that the value of these figures are interchangeable. Just because a company has a high equity multiplier, such as 10.0, does not mean they are a bad company, they could just be a young company leveraging debt to grow fast. Or if they have a low net profit margin such as .2%, they could also just be young. Understanding a company’s goals and plans are just as important as understanding its Du Pont analysis.

The Du Pont analysis is one to use when looking for an investment you plan to hold for 5+ years. If you can find a company that shows substantial improvement in the Du Pont analysis while also showing efforts to innovate it might just be a golden investment.

-Darnel Shillingford

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