DuPont Analysis

Return on equity can be high for very different reasons: strong profitability, efficient use of assets or heavy borrowing. DuPont analysis separates these effects.

The three parts multiply together to give ROE. Net profit margin is net income divided by revenue. Asset turnover is revenue divided by total assets. The equity multiplier is total assets divided by shareholders' equity, which reflects how much the company relies on debt.

For example, a company with a net profit margin of 7.5%, asset turnover of about 1.33 and an equity multiplier of 1.875 has an ROE of about 18.75%.

The analysis shows where to look. If two companies have the same ROE of 18%, but one achieves it mainly through high margins and the other mainly through high leverage, the second is likely riskier. If a company's ROE rises, DuPont analysis can show whether the improvement came from better profitability, more efficient use of assets or simply more borrowing.

The method is named after the DuPont chemical company, where it was developed in the early twentieth century. Extended versions split profit margin further to separate the effects of tax and interest.