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# Du Pont analysis

last edited by 10 years, 1 month ago

# DuPont Analysis:

$\text{ROE}=\frac{\text{Net profit}}{\text{Sales}} \times \frac{\text{Sales}}{\text{Assets}} \times \frac{\text{Assets}}{\text{Equity}}$

The Du Pont Identity (also known as Du Pont analysis or Dupont analysis) is an expression which breaks ROE (Return On Equity) into three parts.




 ROE  = (Net profit / Sales) * (Sales / Assets) *  (Assets / Equity)
=    (Profit margin)   * (Asset turnover) * (Equity multiplier)


The Du Pont identity breaks down Return on Equity (that is, the return to equity that investors have contributed to the firm) into three distinct elements. This analysis allows the analyst to understand where superior (or inferior) return is derived from by comparison with companies in similar industries (or between industries).

The Du Pont identity is less useful for some industries, such as banking, that do not use certain of the concepts or for which the concepts are less meaningful. Variations may be used in certain industries, as long as they also respect the underlying structure of the Du Pont identity.

Du Pont analysis relies upon the accounting identity, that is, a statement (formula) that is by definition true.

## Examples

### High turnover industries

Certain types of retail establishments, particularly grocery stores, may have very low profit margins on sales, and relatively moderate leverage. In contrast, though, groceries may have very high turnover, selling a significant multiple of their assets per year. The ROE of such firms may be particularly dependent on performance of this metric, and hence asset turnover may be studied extremely carefully for signs of under or over-performance. For example, same store sales of many retailers is considered important as an indication that the firm is deriving greater profits from existing stores (rather than showing improved performance by continually opening new stores).

### High margin industries

Other industries, such as fashion, may derive a substantial portion of their competitive advantage from selling at a higher margin, rather than higher sales. For high-end fashion brands, increasing sales without sacrificing margin may be critical. The Du Pont identity allows analysts to determine which of the elements is dominant in any change of ROE.

### High leverage industries

Some sectors, such as the financial sector, rely on high leverage to generate acceptable ROE. In contrast, however, many other industries would see high levels of leverage as unacceptably risky. Du Pont analysis allows the third party (relying primarily on the financial statements) to compare leverage with other financial elements that determine ROE between similar companies.

## ROI and ROE ratio

The return on investment (ROI) ratio developed by Du Pont for its own use it is now used by many firms to evaluate how effectively assets are used. It measures the combined effects of profit margins and asset turnover.[1]

$\text{ROI}=\frac{\text{Net income}}{\text{Sales}} \times \frac{\text{Sales}}{\text{Total assets}}=\frac{\text{Net income}}{\text{Total assets}}$

The return on equity (ROE) ratio is a measure of the rate of return to stockholders.[2] Decomposing the ROE into various factors influencing company performance is often called the Du Pont system.[3]

$\text{ROE}=\frac{\text{Net profit}}{\text{Equity}}=\frac{\text{Net profit}}{\text{Pretax profit}} \times \frac{\text{Pretax profit}}{\text{EBIT}} \times \frac{\text{EBIT}}{\text{Sales}} \times \frac{\text{Sales}}{\text{Assets}} \times \frac{\text{Assets}}{\text{Equity}}$
Where

This decomposition presents various ratios used in fundamental analysis.

• The company's tax burden is (Net profit ÷ Pretax profit). This is the proportion of the company's profits retained after paying income taxes.
• The company's interest burden is (Pretax profit ÷ EBIT). This will be 1.00 for a firm with no debt or financial leverage.
• The company's operating profit margin or return on sales (ROS) is (EBIT ÷ Sales). This is the operating profit per dollar of sales.
• The company's asset turnover (ATO) is (Sales ÷ Assets).
• The company's leverage ratio is (Assets ÷ Equity), which is equal to the firm's debt to equity ratio + 1. This is a measure of financial leverage.
• The company's return on assets (ROA) is (Return on sales x Asset turnover).
• The company's compound leverage factor is (Interest burden x Leverage).

ROE can also be stated as:[4]

ROE = Tax burden x Interest burden x Margin x Turnover x Leverage
ROE = Tax burden x ROA x Compound leverage factor

Profit margin is (Net profit ÷ Sales), so the ROE equation can be restated:

$\text{ROE}=\frac{\text{Net profit}}{\text{Sales}} \times \frac{\text{Sales}}{\text{Assets}} \times \frac{\text{Assets}}{\text{Equity}}$