Foot Locker, Inc. (NYSE: FL) delivered an outstanding 21.0% ROE over the past year, compared to the 8.8% return generated by the Consumer Discretionary sector. Foot Locker’s results may indicate management is running a highly efficient business relative to its peers, which may very well be the case, but it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components may change your view on Foot Locker’s performance and future prospects. I show you exactly what I mean in my DuPont analysis below.
How To Calculate Foot Locker’s ROE
Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. Return on Equity or ROE is generally calculated using the following formula:
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. However, it is important to note that ROE can be “manufactured” by management with the use of leverage or debt.
The return on equity achieved by Foot Locker over the last few years is shown below.
source: finbox.io data explorer – ROE
It appears that the return on equity of Foot Locker has generally been increasing over the last few years. ROE increased from 20.9% to 24.0% in fiscal year 2016, increased to 25.4% in 2017 and decreased to 21.0% as of LTM Oct’17. So what’s causing the general improvement?
Understanding Foot Locker’s Improving Return On Equity
The DuPont analysis is another way to calculate a company’s ROE using the following three metrics:
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 what exactly is causing Foot Locker’s improving returns?
Net Profit Margin Trends
It appears that the net profit margin of Foot Locker has generally been increasing over the last few years. Margins increased from 7.3% to 8.2% in fiscal year 2016, increased to 8.6% in 2017 and decreased to 7.2% as of LTM Oct’17.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at Foot Locker’s efficiency performance to see if that is also boosting ROE.
Asset Turnover Trends
It appears that asset turnover of Foot Locker has generally been increasing over the last few years. Turnover decreased from 2.02x to 2.02x in fiscal year 2016, increased to 2.04x in 2017 and increased again to 2.05x as of LTM Oct’17.
source: data explorer – asset turnover
Therefore, the company’s increasing asset turnover ratio helps explain, at least in part, why ROE is also increasing.
Finally, the DuPont constituents that make up Foot Locker’s ROE are shown in the table below. Note that the table also compares Foot Locker to a peer group that includes Under Armour, Inc.(NYSE: UAA), Dick’s Sporting Goods Inc (NYSE: DKS), Burlington Stores, Inc. (NYSE: BURL) and L Brands, Inc. (NYSE: LB).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Foot Locker’s general improvement in return on equity is the result of an improving net profit margin, an improving asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Foot Locker shareholders have reason to be excited due to the company’s general improvement in profitability along with a general improvement in operational efficiency and declining leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. But before making an investment decision, I recommend you continue to research Foot Locker to get a more comprehensive view of the company by looking at:
Valuation Metrics: how much upside do shares of Foot Locker have based on Wall Street’s consensus price target? Take a look at our analyst upside data explorer that compares the company’s upside relative to its peers.
Risk Metrics: how is Foot Locker’s financial health? Find out by viewing our financial leverage data metric which plots the dollars in total assets for each dollar of common equity over time.
Efficiency Metrics: is management becoming more or less efficient over time? Find out by analyzing the company’s asset turnover ratio which measures the dollars in revenue a company generates per dollar of assets.
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.