Stanley Black & Decker, Inc.’s (NYSE: SWK) most recent return on equity was an above average 17.6% in comparison to the Industrials sector which returned 10.1%. Though Stanley Black & Decker’s performance over the past twelve months is impressive, it’s useful to understand how the company achieved its healthy ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on Stanley Black & Decker and its future prospects.
ROE Trends Of Stanley Black & Decker
Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. It is calculated as follows:
ROE = Net Income To Common / Average Total Common Equity
ROE is a helpful metric that illustrates how effective the company is at turning the cash put into the business into gains or returns for investors. But it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.
The return on equity of Stanley Black & Decker is shown below.
source: finbox.io data explorer – ROE
It appears that the return on equity of Stanley Black & Decker has generally been increasing over the last few years. ROE increased from 14.6% to 15.8% in fiscal year 2016, increased to 17.6% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the general improvement?
Stanley Black & Decker’s Improving ROE Trends
In addition to the formula previously discussed, there’s actually another way to calculate ROE. It’s often called the DuPont formula and is as follows:
Return on Equity = Net Profit Margin * Asset Turnover * Equity Multiplier
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So let’s take a closer look at the drivers behind Stanley Black & Decker’s returns.
Net Profit Margin
It appears that the net profit margin of Stanley Black & Decker has generally been increasing over the last few years. Margins increased from 8.1% to 8.5% in fiscal year 2016 and increased again to 9.6% in 2017.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at Stanley Black & Decker’s efficiency performance to see if that is also boosting ROE.
It appears that asset turnover of Stanley Black & Decker has generally been steady over the last few years. Turnover increased from 0.72x to 0.74x in fiscal year 2016 but then decreased to 0.73x in 2017.
source: data explorer – asset turnover
Therefore, the company’s ROE improvement is not as a result of its asset turnover performance which has generally been steady.
Finally, the DuPont constituents that make up Stanley Black & Decker’s ROE are shown in the table below. Note that the table also compares Stanley Black & Decker to a peer group that includes Illinois Tool Works Inc. (NYSE: ITW), Masco Corporation (NYSE: MAS), Whirlpool Corporation (NYSE: WHR) and Fortune Brands Home & Security, Inc. (NYSE: FBHS).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Stanley Black & Decker’s general improvement in return on equity is the result of an improving net profit margin, a steady asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Stanley Black & Decker shareholders have reason to be excited due to the company’s general improvement in profitability and declining leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. If you have not done so already, I highly recommend that you continue to research Stanley Black & Decker.
Author: Matt Hogan
Expertise: Valuation, financial statement analysis
Matt Hogan is also a co-founder of finbox.io. His expertise is in investment decision making. Prior to finbox.io, Matt worked for an investment banking group providing fairness opinions in connection to stock acquisitions. He spent much of his time building valuation models to help clients determine an asset’s fair value. He believes that these same valuation models should be used by all investors before buying or selling a stock.
Matt can be reached at email@example.com.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.