DuPont Analysis

The DuPont analysis is a method of analyzing performance (return on equity, or ROE) created by none other than the DuPont Corporation.

It’s a step up from the traditional ROE calculation, because 1) It can incentivize managers to be more efficient managers, and 2) It can help investors get a better sense for whether a company is improving management or being risky. The traditional ROE calculation doesn’t incentivize managers to be efficient, and can actually be misleading to investors, since one factor can be a sign of something good happening, or something...not-so-good.

The DuPont analysis includes three main metrics: profit margin (which measures operating efficiency), asset turnover (which measures asset use efficiency), and equity multiplier (which measures financial leverage, i.e. borrowing money). That second part—using asset turnover instead of net asset value—is key to encouraging managers to figure out how to be more efficient.

When an investor looks at the ROE using the DuPont analysis, they can see if a company improved its ROE from smarter management or from an increase in borrowing money. If a company borrowed money without an increase in net income, that looks like poor management, since the debt didn’t provide additional value for the company. If, on the other hand, net income increased and asset turnover was improved, that looks like the company figured out how to do more with less.

Someone’s a smart cookie over there.