What Is the DuPont Analysis?
The DuPont analysis 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). The
decomposition of ROE allows investors to focus on the key metrics of financial
performance individually to identify strengths and weaknesses.
There are two versions of the tool—one which accounts for decomposition in
three steps while the other does so in five steps.
KEY TAKEAWAYS
The DuPont analysis is a framework for analyzing fundamental
performance originally popularized by the DuPont Corporation.
The formula was developed in 1914 by F. Donaldson Brown, an employee
of the DuPont Corporation.
DuPont analysis is a useful technique used to decompose the different
drivers of return on equity.
An investor can use analysis tools 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.
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×EMwhere:Net Profit Margin=Net I
ncomeRevenueAT=Asset turnoverAsset Turnover=SalesAverage Total Asset
sEM=Equity multiplierEquity Multiplier=Average Total AssetsAverage Shar
eholders’ EquityDuPont Analysis=Net Profit
Margin×AT×EMwhere:Net Profit Margin=RevenueNet Income
AT=Asset turnoverAsset Turnover=Average Total AssetsSales
EM=Equity multiplierEquity Multiplier=Average Shareholders’ Eq
uityAverage Total Assets
Advantages of DuPont Analysis
The advantages of DuPont Analysis extend much further than its ability to
calculate a company's ROE. By calculating the three ratios within the
DuPont formula—the net profit margin, asset turnover, and equity
multiplier—it offers an in-depth understanding of the operational and
financial practices that contribute to a company's profitability.
Specifically, it sheds light on a company's cost controls and profit-
generating abilities by evaluating net profit margin. By scrutinizing asset
turnover, it illuminates how well a company is making use of its assets to
generate revenue. Also, by assessing the equity multiplier, it gives insight
into the level of risk a company is engaged with by leveraging debt to
finance its operations.
Profitability Insights: The net profit margin segment of DuPont
Analysis brings to light how effective a company is at generating
profit from its sales. By focusing on this ratio, businesses can
improve their cost controls and profit-centric strategies.
Assets Utilization: The asset turnover ratio helps a business
comprehend how well it is using its assets to generate sales. A lower
ratio indicates that a company may be investing excessively in assets
which aren't being efficiently used, signalling a need for strategic
changes in asset management.
Financial Leverage Assessment: The equity multiplier allows a
firm to understand how much it relies on debt financing. With this
knowledge, a company can make informed decisions about its
capital structure.
Drawbacks
While the DuPont analysis model can be a very helpful tool for investors, it is not
without its weaknesses. The expansive nature of the DuPont analysis means that it
requires several inputs. As with any calculation, the results are only as good as the
accuracy of the inputs. DuPont analysis utilizes data from a company's income
statement and balance sheet, some of which may not be entirely accurate. Even if
the data used for calculations are reliable, there are still additional potential
problems, such as the difficulty of determining the relative values of ratios as
good or bad compared to industry norms. Financial ratios are always best
evaluated on a comparison basis, showing how well a company is performing
compared to its closest business peers or how well the company is doing in
comparison with its own historical performance.
