DuPont analysis

What it means

DuPont analysis breaks return on equity, ROE, into three parts: profit margin, asset turnover and financial leverage. Multiplied together they give ROE, but each tells a different story about where the owners’ return comes from.

Profit margin shows how much profit is left from each euro of sales. Asset turnover shows how much sales the company generates from each euro of assets, meaning how efficiently it uses them. Financial leverage shows how much of the assets is financed by debt relative to equity.

Two companies with the same ROE can be entirely different. One earns through a high margin on low turnover, another through a thin margin on high turnover, a third thanks to heavy debt. The last is the most vulnerable when sales fall, even though its ROE looks just as good.

How it works in practice

In management reporting we use the DuPont breakdown to explain why ROE changed from one year to the next. If the increase comes only from more debt rather than a better margin or efficiency, it is a signal for caution, not celebration.

The extended version adds two further components: the tax burden and the interest burden. That separates how much of the owners’ return goes on tax and how much on interest, and helps assess, for example, the effect of refinancing.

For benchmarking against competitors, published financial statements from the register are enough. A DuPont breakdown quickly shows whether a competitor earns on price, on stock turnover or on debt, and where the company has room to improve.

What to watch out for

With negative or very small equity, ROE and the DuPont breakdown produce meaningless figures. It is then better to track return on assets, ROA, and leverage separately.

The second mistake is comparing companies from different sectors. Retail naturally has a low margin and high turnover, manufacturing the reverse. DuPont analysis makes sense over time for the same company or against similar companies in the sector.