What Is The DuPont Analysis

What Is the DuPont Analysis?
The DuPont analysis (also known as the DuPont identity or DuPont model) is a framework
for analyzing fundamental performance popularized by the DuPont Corporation. DuPont
analysis is a useful technique used to decompose the different drivers of return on equity
(ROE). Decomposition of ROE allows investors to focus on the key metrics of financial
performance individually to identify strengths and weaknesses.
There are three major financial metrics that 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 total sales or revenue. Asset use efficiency
is measured by the asset turnover ratio. Leverage is measured by the equity multiplier,
which is equal to average assets divided by average equity.
Formula and Calculation of DuPont Analysis

The Dupont analysis is an expanded return on equity formula, calculated by multiplying
the net profit margin by the asset turnover by the equity multiplier.
DuPont Analysis=Net Profit Margin × AT × EM
where:
Net Profit Margin=Net Income/ Revenue
AT=Asset turnover
Asset Turnover=Sales/ Average Total Assets
EM=Equity multiplier
Equity Multiplier=Average Total Assets/ Average Shareholders’ Equity
DuPont Analysis
What DuPont Analysis Tells You

A DuPont analysis is used to evaluate the component parts of a company's return on
equity (ROE). This allows an investor to determine what financial activities are
contributing the most to the changes in ROE. An investor can use analysis like this to
compare the operational efficiency of two similar firms. Managers can use DuPont
analysis to identify strengths or weaknesses that should be addressed.
KEY TAKEAWAYS
 The DuPont analysis is a framework for analyzing fundamental performance

originally popularized by the DuPont Corporation.
 DuPont analysis is a useful technique used to decompose the different drivers of
return on equity (ROE).
 An investor can use analysis like this to compare the operational efficiency of two
similar firms. Managers can use
 DuPont analysis to identify strengths or weaknesses that should be addressed.
DuPont Analysis Components

DuPont analysis breaks ROE into its constituent components to determine which of these
factors are most responsible for changes in ROE.
Net Profit Margin

The net profit margin is the ratio of bottom line profits compared to total revenue or total
sales. This is one of the most basic measures of profitability.
One way to think about net margin is to imagine a store that sells a single product for
$1.00. After the costs associated with buying inventory, maintaining a location, paying
employees, taxes, interest, and other expenses, the store owner keeps $0.15 in profit
from each unit sold. That means the owner's profit margin is 15%, which can be calculated
as follows:
Profit Margin=Net Income/ Revenue=$0.15/$1=15%
The profit margin can be improved if costs for the owner were reduced or if prices were
raised, which can have a large impact on ROE. This is one of the reasons that a
company's stock will experience high levels of volatility when management makes a
change to its guidance for future margins, costs, and prices.
Asset Turnover Ratio

The asset turnover ratio measures how efficiently a company uses its assets to generate
revenue. Imagine a company had $100 of assets, and it made $1,000 of total revenue
last year. The assets generated 10 times their value in total revenue, which is the same
as the asset turnover ratio and can be calculated as follows:
Asset Turnover Ratio=Revenue/ Average Assets=$1000/$1,00=10
A normal asset turnover ratio will vary from one industry group to another. For example,
a discount retailer or grocery store will generate a lot of revenue from its assets with a
small margin, which will make the asset turnover ratio very large. On the other hand, a
utility company owns very expensive fixed assets relative to its revenue, which will result
in an asset turnover ratio that is much lower than that of a retail firm.
The ratio can be helpful when comparing two companies that are very similar. Because
average assets include components like inventory, changes in this ratio can signal that
sales are slowing down or speeding up earlier than it would show up in other financial
measures. If a company's asset turnover rises, its ROE will improve.
Financial Leverage
Financial leverage, or the equity multiplier, is an indirect analysis of a company's use of
debt to finance its assets. Assume a company has $1,000 of assets and $250 of owner's
equity. The balance sheet equation will tell you that the company also has $750 in debt
(assets - liabilities = equity). If the company borrows more to purchase assets, the ratio
will continue to rise. The accounts used to calculate financial leverage are both on the
balance sheet, so analysts will divide average assets by average equity rather than the
balance at the end of the period, as follows:
Financial Leverage=Average Assets/ Average Equity=$1000/$250=4
Most companies should use debt with equity to fund operations and growth. Not using
any leverage could put the company at a disadvantage compared with its peers. However,
using too much debt in order to increase the financial leverage ratio—and therefore
increase ROE—can create disproportionate risks.
DuPont Analysis vs. ROE

The return on equity (ROE) metric is net income divided by shareholders’ equity. The
Dupont analysis is still the ROE, just an expanded version. The ROE calculation alone
reveals how well a company utilizes capital from shareholders.
With a Dupont analysis, investors and analysts can dig into what drives changes in ROE,
or why an ROE is considered high or low. That is, a Dupont analysis can help deduce
whether its profitability, use of assets or debt that’s driving ROE.
Limitations of Using DuPont Analysis

The biggest drawback of the DuPont analysis is that, while expansive, it still relies on
accounting equations and data that can be manipulated. Plus, even with its
comprehensiveness, the Dupont analysis lacks context as to why the individual ratios are
high or low, or even whether they should be considered high or low at all.

What Is The DuPont Analysis

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What Is the DuPont Analysis?

Formula and Calculation of DuPont Analysis

DuPont Analysis=Net Profit Margin × AT × EM

Net Profit Margin=Net Income/ Revenue

Asset Turnover=Sales/ Average Total Assets

Equity Multiplier=Average Total Assets/ Average Shareholders’ Equity

What DuPont Analysis Tells You

 The DuPont analysis is a framework for analyzing fundamental performance

DuPont Analysis Components

Net Profit Margin

Profit Margin=Net Income/ Revenue=$0.15/$1=15%

Asset Turnover Ratio

Asset Turnover Ratio=Revenue/ Average Assets=$1000/$1,00=10

Financial Leverage=Average Assets/ Average Equity=$1000/$250=4

DuPont Analysis vs. ROE

Limitations of Using DuPont Analysis

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