DuPont analysis


DuPont Analysis is an expression which breaks ROI into three parts.
The name comes from the DuPont Corporation that started using this formula in the 1920s. DuPont explosives salesman Donaldson Brown invented this formula in an internal efficiency report in 1912.

Basic formula

ROE = ** = ** = Or Profit/Sales*Sales/Assets=Profit/Assets*Assets/Equity Or ROS*AT=ROA*Leverage=ROE
The DuPont identity breaks down ROI into three distinct elements. This analysis enables the analyst to understand the source of superior return by comparison with companies in similar industries.
The DuPont identity is less useful for industries such as investment banking, in which the underlying elements are not meaningful. Variations of the DuPont identity have been developed for industries where the elements are weakly meaningful.

Examples

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 DuPont identity allows analysts to determine which of the elements is dominant in any change of ROE.

High turnover industries

Certain types of retail operations, particularly 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.

High leverage industries

Some sectors, such as the financial sector, rely on high leverage to generate acceptable ROE. Other industries would see high levels of leverage as unacceptably risky. DuPont analysis enables third parties that rely primarily on their financial statements to compare leverage among similar companies.

ROA and ROE ratio

The return on assets ratio developed by DuPont 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 ratio is a measure of the rate of return to stockholders. Decomposing the ROE into various factors influencing company performance is often called the DuPont system.
This decomposition presents various ratios used in fundamental analysis.