salesforce.com, inc. (NYSE: CRM) underperformed the Information Technology sector by -3.7% as it relates to ROE, producing a low 0.1% compared to the sector’s 3.8%. But what is more interesting is whether salesforce will continue to post subpar returns moving forward. The DuPont analysis is a useful tool that may help us determine this. In my analysis below, I’ll use the DuPont model to reveal what’s really driving the company’s low ROE.
salesforce’s ROE Trends
Return on equity or ROE represents the percentage return a company generates on the money shareholders have invested.
ROE = Net Income To Common / Average Total Common Equity
In general, a higher return on equity suggests management is utilizing the capital invested by shareholders efficiently. However, it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.
salesforce’s recent ROE trends are illustrated in the chart below.
source: finbox.io data explorer – ROE
It appears that the return on equity of salesforce has generally been increasing over the last few years. ROE increased from -7.5% to -1.1% in fiscal year 2016, increased to 2.9% in 2017 and decreased to 0.1% as of LTM Oct’17. So what’s causing the general improvement?
What’s Causing salesforce’s Improving Return On Equity
A less used approach although being much more intuitive, the DuPont formula is another way to calculate a company’s ROE. It is defined as:
ROE = Net Profit Margin * Asset Turnover * Equity Multiplier
Created by the DuPont Corporation in the 1920s, the analysis is a useful tool that helps determine what’s responsible for changes in a company’s ROE. It highlights that a firm’s ROE is affected by three things: profit margin, asset turnover, and its equity multiplier or financial leverage.
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 what’s causing salesforce’s improving returns.
salesforce’s Net Profit Margin Trends
It appears that the net profit margin of salesforce has generally been increasing over the last few years. Margins increased from -4.9% to -0.7% in fiscal year 2016, increased to 2.1% in 2017 and decreased to 0.1% 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 salesforce’s efficiency performance to see if that is also boosting ROE.
salesforce’s Asset Turnover Trends
It appears that asset turnover of salesforce has generally been increasing over the last few years. Turnover increased from 0.54x to 0.57x in fiscal year 2016, decreased to 0.55x in 2017 and increased to 0.62x 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 salesforce’s ROE are shown in the table below. Note that the table also compares salesforce to a peer group that includes Vmware, Inc. (NYSE: VMW), Zendesk, Inc. (NYSE: ZEN), SAP SE (NYSE: SAP) and Oracle Corporation (NYSE: ORCL).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that salesforce’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, salesforce 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. However, it doesn’t necessarily tell the whole story. For example, how do the company’s ROE trends compare to its peers or sector? How about in absolute returns? I recommend that investors continue to research salesforce to gain a better understanding of its fundamentals before making an investment decision.
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.