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.
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Finance: What is ROE?1 Views
Finance a la shmoop What is r o e or
a return on equity when you go to a fancy
sushi bar while those little orange eggs cost a small
fortune they come from libertarian salmon and tastes like assault
licked from your grandmother's purse So that's row but well
has nothing to do with this kind of row or
return on equity Different thing Alright so very simply Anytime
you see a ratio that's return on anything It means
profits in the numerator Sitting on something in the denominator
like return on sales is a company's profit margin right
You have profits divided by sales and well that's Pretty
easy calculation to make if you have the data so
return on equity Well that's a little bit different in
that finding What you mean by equity is sometimes a
bit of a moving target or a religious discussion in
the way the equity line on the balance sheet was
in fact calculated In essence the equity value of a
company is what it owns over time Like it accumulates
equity profits in the brand equity and patents and a
whole bunch of other crap And it owns all that
Got it it's The equity value of the firm like
the cash profits is generated over a long period of
time with the cash it's received from investors plus fair
value of all the patents and brands and distribution infrastructure
and eighteen zillion other elements that all add up together
when you subtract liabilities from assets to get that either
that's the yeah they all come together to comprise whatever
number is placed as the equity of the firm So
if you go back to our friendly little lemonade stand
with twelve grand in profits or returns and equity of
thirty six grand then it's row is yes one third
or thirty three percent Well is that good Bad ugly
Well in a vacuum we don't really know Because each
industry command such different kinds of numbers when it comes
to the efficient use of its equity a lemonade stand
needs well relatively very little capital expenditure to get started
It should have very high returns from its equity because
its profit margin should be very high When it's selling
for a dollar something that costs a dime you can
think of that thirty three percent return on equity as
being something that might map to investing in a stock
market reflective index fund and yes thirty three percent a
year return from any kind of stock market investment Overtime
is heroic The problem While the return number is likely
highly volatile in a company with such massive return on
equity that is yes So this year our little lemonade
stand made twelve grand But next year it might lose
five the following year make twenty and then the following
year well goes bankrupt So the r o e number
for a company is so fragile what's on the edge
of meaningless really compare the row for a large oil
company Well oil is massively less volatile as an industry
That is our little lemonade stand and oils One of
the more volatile industries just light A match there happened
and twenty billion dollars well just buys you a well
some storage tanks a little distribution infrastructure and hopefully a
decent line Teo getting your money back eventually So if
you measure the return on equity of a big oil
company over a ten year cycle well you might find
that return is only four and a half percent Well
That equity could have been deployed almost certainly in the
investing community like an index finding factor whatever and done
much better than what the managers of the oil company
did in putting all that money in the ground through
wells and exploration and refining and so on So is
an unschooled investor You might begin to be leaning on
management to take their cash and do something else with
it Like how about investing it in an internet search
company Yeah we need another one of those You know
those google people had really high r o e let's
do more of that And then one day a bomb
goes off in the middle east Big one Oil prices
go from fifty bucks a barrel to one hundred And
for the following decade the r o e of the
oil company looks a lot more like that Thirty three
percent fromthe lemonade company And the investor who pushed shell
to fund a google competitors goes back to work making
fives and tens and change at bank of america and
pushing customers to you know refinance their more Well the
bottom line is that are we is a moving target
At best and only exists in the vague never land
of time And that contextually It only means something when
mapped against the whole host of other things that players
could do with their money So if you're companies trying
to stay above water and you start smelling something fishy 00:04:16.772 --> [endTime] well you know it might just be the row