DuPont Analysis

DuPont Analysis

ROE - Return on Equity - is a prime indicator as to whether the firm creates or consumes wealth. In its simplest form, ROE is computed as:

ROE = ------------------
      Shareholder Equity

DuPont analysis breaks the ROE down into components, for deeper analysis.

The components are:
  1. Net Margin     - how much profit is generated from unit of revenue
  2. Asset Turnover - how much revenue is generated from unit of assets
  3. Leverage       - how much in assets the firm has per unit of equity

The formuli for the above are obvious from their definitions:

      Net Income   Sales    Assets
ROE = ---------- * ------ * ------
         Sales     Assets   Equity
The DuPont method allows for even deeper analysis by breaking up the above into more granular factors.

         Net Income    Pretax Profit   EBIT    Sales    Assets
ROE =  ------------- * ------------- * ----- * ------ * ------
       Pretax Profit        EBIT       Sales   Assets   Equity

The last 2 factors come directly from the 3-component DuPont formula.

The first 3 factors are the breakdown of Net Income / Sales component:

Net Income    Net Income     Pretax Profit   EBIT
---------- = ------------- * ------------- * -----
  Sales      Pretax Profit       EBIT        Sales

Breaking this down, right to left:

EBIT/Sales           - Earnings Before Interest and Taxes per unit of sales
Pretax Profit/EBIT   - PT Profit per unit of EBIT (ie removes interest)
Net Income/PT Profit - Net income per unit of PTP (ie removes taxes)

The product of the 3 above equals the Net Income / Sales ratio