A type of analysis that examines a company's Return on Equity (ROE) by breaking it into three main components: profit margin, asset turnover and leverage factor. By breaking the ROE into distinct parts, investors can examine how effectively a company is using equity, since poorly performing components will drag down the overall figure. To calculate a firm's ROE through Du Pont analysis, multiply the profit margin (net income divided by sales), asset turnover (sales divided by assets) and leverage factor (total assets divided by shareholders' equity) together. The higher the result, the higher the return on equity. A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). It is also known as "DuPont identity".
DuPont analysis tells us that ROE is affected by three things: - Operating efficiency, which is measured by profit margin
- Asset use efficiency, which is measured by total asset turnover - Financial leverage, which is measured by the equity multiplier
ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)
ROI and ROE ratio
The return on investment (ROI) ratio developed by Du Pont for its own use is now used by many firms to evaluate how effectively assets are used. It measures the combined effects of profit margins and asset turnover.
The return on equity (ROE) ratio is a measure of the rate of return to stockholders. Decomposing the ROE into various factors influencing company performance is often called the Du Pont system. [pic]
• Net profit = net profit after taxes
• Equity = shareholders' equity
• EBIT = Earnings before interest and taxes
• Sales = Net sales