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How Do These Telecoms Really Make Their Money? (AMX, T, VZ) Fool.comGrowing the love for investingWelcome! Premium Advice My Services None Other Services Alpha Big Short Duke Street Global Gains Hidden Gems Income Investor Inside Value Million Dollar Portfolio Motley Fool Options Motley Fool Pro Rule Breakers Rule Your Retirement Special Ops Stock Advisor HelpJoin NoworLogin The Motley Fool Home All Fool Headlines Fool Labs Foolanthropy About The Motley Fool My Fool My Profile My Watchlist My Boards My CAPS My Reports My Settings How To Invest 13 Steps Find a Broker Investing Wiki Personal Finance Investing Commentary Basics ETFs Options Small-Cap Dividends & Income High Growth Value Mutual Funds International CAPS Community CAPS Home CAPS Home My CAPS Stocks Screener Players Blogs Top Tens Tags Contests Contact Us Help Retirement 13 Retirement Steps IRAs 401(k)s, Etc. Asset Allocation Boards Best Of Favorites & Replies Customize Start a New Board Fool Store Stock Advisor Hidden Gems Rule Breakers Income Investor Million Dollar Portfolio Motley Fool PRO Global Gains
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2 How Do These Telecoms Really Make Their Money? ByJim Royal|More ArticlesDecember 30, 2010|Comments (1) Don't let it get away!Keep track of the stocks that matter to you.
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As investors, we need to understand how our companies truly make their money. And there's a neat trick developed for just that purpose. It's called the Dupont formula.
By using the Dupont formula, you can get 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 Dupont formula breaks down return on equity into three components.
Return on equity = net margins X asset turnover X leverage ratio
High net margins show that a company is able to get customers to pay more for its products. Think luxury goods companies. High asset turnover indicates that a company needs to invest less of its capital, since it uses its assets more efficiently to generate sales. Think service industries, which often do not have high capital investments. Finally, the leverage ratio shows how much the company is relying on debt to create profit.
Generally, the higher these numbers, the better. Of course, too much debt can sink a company, so beware of companies with very high leverage ratios.
Let's take a look at AT&T (NYSE: T) and a few of its sector and industry peers.
Company Return on Equity Net Margins Asset Turnover Leverage RatioAT&T
19.8%
17.6%
0.46
2.52
Vodafone (NYSE: VOD)
12.8%
25.1%
0.29
1.76
Verizon (NYSE: VZ)
1.1%
0.4%
0.48
5.51
America Movil (NYSE: AMX)
31.9%
17.8%
0.63
2.83
Source: Capital IQ, a division of Standard & Poor's.
AT&T has a strong return on equity, with net margins that are comparable to those of America Movil. However, the latter uses more leverage and greater asset turnover to boost its return on equity. With its business model, Vodafone has the fattest margins of the lot, but substantially lower leverage and asset turnover bring its return on equity down. Verizon has seen its return on equity trending lower in recent years. Its leverage and asset turnover are comparable with peers', but it seems to be losing out on margins. The situation should improve in the coming year, as Verizon's trailing margins are dragged down in part because of massive writedowns.
Breaking down a company's return on equity can often give you some insight into how it's competing against peers and what type of strategy it's using to juice its return on equity.
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Jim Royal, Ph.D., owns shares of Vodafone. Vodafone is a Motley Fool Inside Value pick. America Movil is a Motley Fool Global Gains choice. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.
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Report this Comment icon found on every comment. Report this Comment On December 31, 2010,at 4:11 AM, Johnexo wrote:Leverage can be good because it can decrease a firm’s cost of capital but too much debt can be dangerous. It is safest to look for firms with no more debt than equity so that their debt-to-equity ratio is less than 1.
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