Loading the player...

What is 'DuPont Analysis'

DuPont analysis is a fundamental performance measurement framework popularized by the DuPont Corporation and is also referred to as the "DuPont identity." DuPont analysis is a useful technique used to decompose the different drivers of the return on equity (ROE). Decomposition of ROE allows investors to focus their research on the distinct company performance indicators otherwise cursory evaluation.

BREAKING DOWN 'DuPont Analysis'

According to DuPont analysis, there are three major financial metrics drive return on equity (ROE): operating efficiency, asset use efficiency and financial leverage. Operating efficiency is represented by net profit margin or net income divided by average shareholders' equity. Asset use efficiency is measured by total asset turnover or the asset turnover ratio. Finally, financial leverage is analyzed through observation of changes in the equity multiplier.

DuPont Analysis Components

DuPont analysis breaks ROE into its constituent components to determine which of these components is most responsible for changes in ROE.

Net margin: Expressed as a percentage of the total revenue, net margin is the revenue that remains after subtracting all operating expenses, taxes, interest and preferred stock dividends from a company's total revenue.

Asset turnover ratio: This ratio is an efficiency measurement used to determine how effectively a company uses its assets to generate revenue. The formula for calculating asset turnover ratio is total revenue divided by total assets. As a general rule, the higher the resulting number, the better the company is performing.

Equity multiplier: This ratio measures financial leverage. By comparing total assets to total stockholders' equity, the equity multiplier indicates whether a company finances the purchase of assets primarily through debt or equity. The higher the equity multiplier, the more leveraged the company, or the more debt it has in relation to its total assets.

DuPont analysis involves examining changes in these figures over time and matching them to corresponding changes in return on equity (ROE). By doing so, analysts can determine whether operating efficiency, asset use efficiency or leverage is most responsible for return on equity (ROE) variations.

DuPont Analysis Calculations

Using basic calculations, DuPont analysis breaks down the relationship between return on equity (ROE) and return on assets (ROA) in mathematical form by the following calculation:

Return on Equity (ROE) = Net Income / Average Shareholders' Equity

= (Net Income / Average Total Assets) x (Average Total Assets / Average Shareholders' Equity)

Which then results in the following outcome:

Return on Equity (ROE) = Return on Assets (ROA) x Leverage

Where:

Leverage = Equity Multiplier

Return on Assets (ROA) = Net Profit Margin % x Total Asset Turnover Ratio (ATO)

The more recognizable DuPont analysis formula comes in the following form:

Return on Equity (ROE) = Net Profit Margin x Asset Turnover Ratio x Equity Multiplier.

Which corresponds to the following interpretation:

Return on Equity (ROE) = (Net Income / Average Shareholders' Equity) = (Net Income / Total Revenue) x (Revenue / Average Total Assets) x (Average Total Assets / Average Shareholders' Equity)

To separate the effect of taxes, the return on equity (ROE) decomposition can be interpreted as:

Return on Equity (ROE) = Tax Burden x Interest Burden x EBIT Margin % x Total Asset Turnover Ratio (ATO) x Equity Multiplier

Where:

Net Profit Margin = Tax Burden x Interest Burden x EBIT Margin %

RELATED TERMS
  1. Equity Multiplier

    The ratio of a company’s total assets to its stockholders’ equity. ...
  2. Asset Turnover Ratio

    Asset turnover ratio measures the value of a company’s sales ...
  3. Profitability Ratios

    Profitability ratios are a class of financial metrics that are ...
  4. Leverage

    Leverage results from using borrowed capital as a source of funding ...
  5. Return

    A return, in finance, is the profit or loss derived from investing ...
  6. Overall Turnover

    Overall turnover is a term commonly used in Europe and Asia to ...
Related Articles
  1. Investing

    Analyzing Facebook's Return on Equity (FB)

    Learn 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.
  2. Investing

    Analyzing UPS's Return on Equity (ROE) (UPS)

    Learn about UPS's return on equity (ROE), an important metric for investors. It is useful to compare the historical ROE and in relation to peers.
  3. Investing

    How Return On Equity Can Help You Find Profitable Stocks

    It pays to invest in companies that generate profits more efficiently than their rivals. This is where ROE comes in.
  4. Investing

    Analyzing Cisco's Return on Equity (ROE) (CSCO)

    Learn about Cisco's ROE and see how the company's most recent results compare to historical results and large-cap networking and communications equipment peers.
  5. Investing

    Analyzing Netflix's Return on Equity (NFLX)

    Analyze the return on equity (ROE) of Netflix, and understand the factors that have caused this metric to oscillate wildly in recent years.
  6. Investing

    Analyzing Toyota's Return on Equity (ROE)

    Analyze the return on equity of Toyota Motor Corporation and understand how the company's net margin has driven its ROE up and down over the past decade.
  7. Investing

    Analyzing Under Armour's Return on Equity (UA)

    Analyze Under Armour's return on equity (ROE) and understand how the company's strong and consistent net margins have resulted in good ROE numbers.
  8. Insights

    How Do Tech Companies Measure ROA And ROE?

    The return on Assets (ROA) and return on equity (ROE) are often used metrics to measure the returns generated by a company.
  9. Investing

    Analyzing Pfizer's Return on Equity (ROE) (PFE)

    Analyze the return on equity (ROE) of Pfizer and understand how changes in the company's net margin have driven its ROE up and down recently.
  10. Investing

    Analyzing BP's Return on Equity (ROE)

    Examine the return on equity (ROE) for British Petroleum, the slumping international energy company that seems to be falling behind its competitors.
RELATED FAQS
  1. What are the main differences between return on equity (ROE) and return on assets ...

    ROE gauges how their investments are generating income; ROA measures how management is using its assets or resources to generate ... Read Answer >>
  2. What is the average return on equity for a company in the financial services sector?

    Learn the importance of calculating a company's return on equity and what businesses in the financial services industry average ... Read Answer >>
  3. Are companies with a negative return on equity (ROE) always a bad investment?

    Any metric that uses net income is basically nullified as an input when a company reports negative profits. Return on equity ... Read Answer >>
  4. Does a High Price-To-Book Ratio Correlate to ROE?

    Learn the correlation between price-to-book (P/B) ratio and return on equity (ROE), and why it can be helpful to use the ... Read Answer >>
  5. How Is Equity and Shareholders' Equity Different?

    A company's equity typically refers to the ownership of a public company. Shareholders' equity is the difference between ... Read Answer >>
  6. How do you calculate a company's equity?

    Company equity, or shareholders' equity, is the net difference between a company's total assets and total liabilities. Read Answer >>
Trading Center