Basic formula
* Profitability: measured by profit margin * Asset efficiency: measured by asset turnover * Financial leverage: measured by equity multiplier : Or : Or :ROE analysis
The DuPont analysis breaks down ROE (that is, the returns that investors receive from a single dollar of equity) into three distinct elements. This analysis enables the analyst to understand the source of superior (or inferior) return by comparison with companies in similar industries (or between industries). The DuPont analysis is less useful for industries such as investment banking, in which the underlying elements are not meaningful. Variations of the DuPont analysis have been developed for industries where the elements are weakly meaningful.Examples
High margin industries
Some industries, such as fashion, may derive a substantial portion of their competitive advantage from selling at a higher margin, rather than higher sales. For high-end fashion brands, increasing sales without sacrificing margin may be critical. The DuPont analysis allows analysts to determine which of the elements is dominant in any change of ROE.High turnover industries
Certain types of retail operations, particularly stores, may have very low profit margins on sales, and relatively moderate leverage. In contrast, though, groceries may have very high turnover, selling a significant multiple of their assets per year. The ROE of such firms may be particularly dependent on performance of this metric, and hence asset turnover may be studied extremely carefully for signs of under-, or, over-performance. For example, same-store sales of many retailers is considered important as an indication that the firm is deriving greater profits from existing stores (rather than showing improved performance by continually opening stores).High leverage industries
Some sectors, such as the financial sector, rely on high leverage to generate acceptable ROE. Other industries would see high levels of leverage as unacceptably risky. DuPont analysis enables third parties that rely primarily on their financial statements to compare leverage among similar companies.ROA and ROE ratio
The return on assets (ROA) ratio developed by DuPont for its own use is now used by many firms to evaluate how effectively assets are used. It measures the combined effects of profit margins and asset turnover. : The return on equity (ROE) ratio is a measure of the rate of return to stockholders. Decomposing the ROE into various factors influencing company performance is often called the DuPont system. : :Where :* Net Income = net income after taxes :* Equity = shareholders' equity :* EBIT =References
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