The DuPont Analysis reduces ROE down into three components – net profit margin, total asset turnover and financial leverage – to arrive at an overall percentage score. Also referred to as the DuPont model or identity, the DuPont method or the strategic profit model, this framework was developed by the DuPont Corporation in the 1920s. It is a well-respected formula used by company financial managers, independent financial advisors and investors alike.

What Is ROE?

ROE is an indication of how profitable a company is in relation to its equity; how well is shareholder equity utilized to generate profit? ROE represents the percentage of profit that is generated by each dollar of shareholder equity. For instance, an ROE of 20% means that each dollar of shareholder equity generates 20 US cents profit.

What Is a Good or Bad ROE Score?

The answer to this question is completely contextual. What makes a good or bad ROE cannot be decided without comparison to other companies in the same industry. Generally, a good ROE is equal to or higher than the average for the company’s industry or sector. This is why ROE is not a good indicator of equity-related profitability when comparing companies across different industries.

Why Are Investors Interested in ROE?

When an investor considers which company to invest in, two key factors of interest are:

What level of dividend payment will they receive? Is the company likely to have a sustainable growth rate?

A company’s ROE can be used to inform both of these factors. For instance, it is possible to calculate a company’s future growth rate by multiplying ROE by retention ratio. The retention ratio is the percentage of net income reinvested or retained to support the company’s future growth: The DuPont Analysis is commonly used by companies to examine their own financial performance, but it can also be useful to investors who wish to check on a company’s equity-related profitability before making an investment. Additionally, financial advisors may use the DuPont analysis to serve their customers. The main benefit of the DuPont analysis is the additional insight provided by drilling down into the drivers of ROE: net profit margin, total asset turnover and financial leverage.

Understanding the DuPont Formulas

The starting point of the DuPont analysis is the ROE formula, which divides net income by shareholder equity: The DuPont analysis is available in two formats – a three step formula and a five step formula.

Three Step Formula

The three step DuPont analysis formula calculates ROE using the following factors:

Net income Sales Assets Shareholder equity

The three step formula is: Equity multiplier (financial leverage) measures the proportion of assets funded by stockholder equity and is a risk indicator.

Five Step Formula

The five step DuPont analysis formula separates operating activities from financing activities to discover how each affects ROE. This is especially useful where a company’s ROE has changed detrimentally. The five step formula uses the following factors:

Earnings before tax Sales Assets Equity Tax rate

The five step formula is:

DuPont Analysis Example

Basic ROE Calculation Example

The DuPont analysis breaks ROE down into net profit margin, total asset turnover and financial leverage to arrive at an overall percentage score – for example, 17%. The main benefit of the DuPont analysis is the additional insight provided by drilling down into the drivers of ROE: net profit margin, total asset turnover and financial leverage. Additionally, it can be a useful method for investors to check on a company’s profitability before making an investment. Financial advisors may also use the DuPont analysis framework to serve their customers.

  1. The formula relies on the figures used, such as sales or assets, being accurate and current to the same timeframe as each other.
  2. A level of knowledge about the company, the industry it is part of and the company’s competitors is required to effectively judge whether the ROE percentage is good or bad in comparison to other companies.
  3. There may be seasonal factors that affect figures used in the DuPont analysis formula, such as the holding of a larger inventory in anticipation of Christmas, for instance.
  4. It is difficult to use ROE to compare companies in different industries. Net profit margin is a measure of profit as a percentage of revenue. Asset turnover is a measure of how effectively a company’s assets are used to generate revenue or income. Financial leverage (represented by the term ‘equity multiplier’ in the DuPont analysis framework) measures the proportion of assets funded by stockholder equity instead of debt and is used as a risk indicator. ROE = net income ÷ shareholder equity By comparison, the DuPont analysis framework arrives at the ROE by considering its driving factors – net profit margin, total asset turnover and financial leverage. This is done through the three step formula: ROE = (net income ÷ sales) × (sales ÷ assets) × (assets ÷ shareholder equity) also expressed as: ROE = net profit margin × asset turnover × equity multiplier or the five step formula: ROE = (earnings before tax ÷ sales) × (sales ÷ assets) × (assets ÷ shareholder equity) × (1 – tax rate) also expressed as: ROE = operating profit margin × asset turnover × equity multiplier × tax retention rate Return on assets (ROA) is an indicator of how well a company’s assets generate revenue. This is a separate but contributing factor to ROE. The five step DuPont analysis formula separates operating activities from financing activities to discover how each affects ROE. It uses operating profit margin, asset turnover, financial leverage (expressed as equity multiplier) and tax retention rate to calculate ROE, factoring in earnings before tax, sales, assets, shareholder equity and tax rate. Progressing from the ROE formula to the three step and then five step formula, more factors are included and hence the ROE result is more exact. In addition, the DuPont analysis offers insight into the drivers of ROE, whether that be net profit margin, financial leverage or asset turnover.

Net income Sales Assets Shareholder equity

If you use the five step DuPont analysis formula, information required includes:

Earnings before tax Sales Assets Shareholder equity Tax rate

The DuPont analysis framework offers the opportunity to drill down into the main drivers of ROE to discover which has the greatest effect on profitability, whether historically, currently or in the future.