What is the 'DuPont Identity'
The DuPont identity is an expression that shows a company's return on equity (ROE) can be represented as a product of three other ratios: the profit margin, the total asset turnover and the equity multiplier. It is also commonly known as DuPont analysis, and it comes from the DuPont Corporation which began using the idea in the 1920s.
BREAKING DOWN 'DuPont Identity'The DuPont identity tells us that ROE is affected by three things:
1. Operating efficiency, which is measured by profit margin;
2. Asset use efficiency, which is measured by total asset turnover;
3. Financial leverage, which is measured by the equity multiplier.
If the ROE is unsatisfactory, the DuPont identity helps analysts and management locate the part of the business that is underperforming.
The formula for the DuPont identity is:
ROE = profit margin x asset turnover x equity multiplier
This formula, in turn, can be broken down further to:
ROE = (net income / sales) x (revenue / total assets) x (total assets / shareholder equity)
DuPont Identity Example Calculation
Assume a company reports the following financial data for two years:
Year one net income = $180,000
Year one revenues = $300,000
Year one total assets = $500,000
Year one shareholder equity = $900,000
Year two net income = $170,000
Year two revenues = $327,000
Year two total assets = $545,000
Year two shareholder equity = $980,000
Using the DuPont identity, the ROE for each year is:
ROE year one = ($180,000 / $300,000) x ($300,000 / $500,000) x ($500,000 / $900,000) = 20%
ROE year two = ($170,000 / $327,000) x ($327,000 / $545,000) x ($545,000 / $980,000) = 17%
With a slight amount of rounding, the above two ROE calculations break down to:
ROE year one = 60% x 60% x 56% = 20%
ROE year two = 52% x 60% x 56% = 17%
You can clearly see the ROE declined in year two. During the year, net income, revenues, total assets and shareholder equity all changed in value. By using the DuPont identity, analysts or managers can break down the cause of this decline. Here they see the equity multiple and total asset turnover remained exactly constant over year two. This leaves only the profit margin as the cause of the lower ROE. Seeing that the profit margin dropped from 60% to 52% while revenues actually increased in year two indicates that there are issues with the way the company handled its expenses and costs throughout the year. Managers can then use these insights to improve the following year.
Learn more about the DuPont analysis by reading What are the main differences between return on equity (ROE) and return on assets (ROA)?
A method of performance measurement that was started by the DuPont ...
The ratio of a company’s total assets to its stockholder’s equity. ...
The amount of net income returned as a percentage of shareholders ...
The amount of sales generated for every dollar's worth of assets ...
A measure of profits shown as a percentage of the capital that ...
Any ratio used to calculate the financial leverage of a company ...
Managing WealthDuPont analysis measures assets at their gross book value, rather than at net book value, in order to produce a higher return on equity (ROE).
InvestingGet a deeper understanding of ROE with these three-step and five-step calculations.
InvestingReturn on equity and return on assets are important measures for evaluating how well a company manages the capital its shareholders entrust to it.
InvestingLearn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
InvestingFind out how Baidu's return on equity (ROE) compares to industry peers and historical results. See how DuPont analysis treats net margin, asset turnover and leverage.
InvestingLearn about Facebook's return on equity (ROE), and find out how it compares to its peers. Discover how net margin, asset turnover and financial leverage impacted its ROE.
InvestingLearn about Boeing's return on equity and find out how the company's ROE compares to its own historical performance and aerospace industry peers.
InvestingAnalyze the return on equity (ROE) of Petroleo Brasileiro, and identify the key factors that have driven the company's ROE down in recent years.
InvestingIt pays to invest in companies that generate profits more efficiently than their rivals. This is where ROE comes in.
InvestingLearn about Apple's return on equity (ROE) in fiscal 2015, and find out how net profit margin, financial leverage and asset turnover impact ROE relative to its peers.
Learn the origins of the DuPont Analysis and how it evaluates the company's financial health by looking at more than profit ... Read Answer >>
Discover how the DuPont analysis system breaks down a company’s return on equity into three parts to fully analyze its efficiency ... Read Answer >>
Learn about the DuPont analysis financial ratio, and understand some of its primary advantages and disadvantages. Read Answer >>
Learn about how DuPont analysis measures financial leverage using the equity multiplier, and see when the equity multiplier ... Read Answer >>
Find out about the relationship between the equity multiplier and the asset turnover ratio and how both are used in the DuPont ... Read Answer >>
Learn about how to calculate the equity multiplier in the three-step DuPont analysis method, and see what impact a higher ... Read Answer >>