What is the 'DuPont Identity'
The DuPont identity is an expression that breaks return on equity (ROE) down into three parts: profit margin, total asset turnover and financial leverage. It is also known as "DuPont Analysis".
DuPont identity tells us that ROE is affected by three things: Operating efficiency, which is measured by profit margin Asset use efficiency, which is measured by total asset turnover Financial leverage, which is measured by the equity multiplier
ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)
BREAKING DOWN 'DuPont Identity'
If ROE is unsatisfactory, the Du Pont identity helps locate the part of the business that is underperforming.
Here is how the DuPont identity is derived:
ROE = NI/TEMultiply by 1 (TA/TA) and then rearrangeROE = (NI / TE) (TA / TA)ROE = (NI / TA) (TA / TE) = ROA * EMMultiply by 1(S/S) and then rearrangeROE = (NI / TA) (TA / TE) (S/S)ROE = (NI / S) (S / TA) (TA / TE)ROE = PM * TAT * EMROE = Profit Margin * Total Asset Turnover * Equity Multiplier
When:ROE = Return on EquityNI = Net IncomeTE = Total EquityTA = AssetsROA = Return on AssetsEM = TA/TE = 1 + D/E = The Equity MultiplierS = Sales
Learn more about the DuPont analysis by reading What are the main differences between return on equity (ROE) and return on assets (ROA)?

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