DuPont Analysis

Overview

DuPont analysis (also called the DuPont identity or DuPont model) decomposes return on equity (ROE) into the operational and financial drivers that produce it. It helps managers and investors identify whether changes in ROE come from profitability, asset use efficiency, or financial leverage.

Key takeaways:
* Breaks ROE into component ratios to pinpoint strengths and weaknesses.
* Useful for comparing operational efficiency among peers.
* Has existed since 1919 and remains widely used, but depends on the quality of accounting inputs.

Core idea and basic formula

ROE is net income divided by shareholders’ equity. The DuPont approach expands ROE into three multiplicative components:

ROE = Net Profit Margin × Asset Turnover × Equity Multiplier

Where:
* Net Profit Margin = Net Income / Revenue
* Asset Turnover = Revenue / Average Total Assets
* Equity Multiplier = Average Total Assets / Average Shareholders’ Equity

Multiplying these three yields ROE and shows whether ROE changes stem from margins, asset efficiency, or leverage.

Components explained

Net Profit Margin

Measures profitability per dollar of sales:
Net Profit Margin = Net Income / Revenue

Example: If a product sells for $1 and yields $0.15 net income, the margin is 15%. Improving margins (higher prices or lower costs) raises ROE directly.

Asset Turnover

Measures how effectively assets generate sales:
Asset Turnover = Revenue / Average Total Assets

Example: $1,000 revenue on $100 in assets gives an asset turnover of 10. Asset turnover varies widely by industry (high for retailers, low for utilities). Rising asset turnover improves ROE.

Equity Multiplier (Financial Leverage)

Shows how much assets are financed by equity vs. debt:
Equity Multiplier = Average Total Assets / Average Shareholders’ Equity

Example: $1,000 assets with $250 equity → equity multiplier = 4. Higher leverage can boost ROE but increases financial risk.

3-step vs 5-step DuPont

• 3-step (common): ROE = (Net Income / Sales) × (Sales / Assets) × (Assets / Equity)
• 5-step (finer): ROE = (EBT / Sales) × (Sales / Assets) × (Assets / Equity) × (1 − Tax Rate)
• EBT = Earnings before tax
• The 5-step version separates pre-tax operating performance and the tax effect.

Example applications

Hypothetical comparison

Two peers improved ROE:
* SuperCo: ROE improvement driven by higher net margin and better asset turnover (operational gains). Equity stayed roughly constant.
* Gear Inc.: ROE improvement came solely from higher financial leverage (more debt), with no change in margin or turnover — a riskier, potentially unsustainable gain.

Interpreting which improvement is preferable depends on sustainability and risk tolerance; operational improvements are generally more durable than leverage-driven gains.

Real-world example (Walmart fiscal year ended Jan. 31, 2025)

Reported figures:
* Net income = $19.4 billion
* Revenue = $681.0 billion
* Total assets = $260.8 billion
* Shareholders’ equity = $97.4 billion

Computed components:
* Profit margin = 19.4 / 681.0 = 2.85%
* Asset turnover = 681.0 / 260.8 = 2.61
* Equity multiplier = 260.8 / 97.4 = 2.68

ROE = 2.85% × 2.61 × 2.68 ≈ 19.9%

Limitations and cautions

• Relies on accounting data that can be manipulated (different accounting policies, one-time items).
• Lacks context—high or low component ratios require industry benchmarks and qualitative assessment.
• Seasonal factors and timing (use of averages) can distort comparisons.
• Increased ROE from leverage raises financial risk and may not create real operational value.

Practical use

Use DuPont analysis to:
* Diagnose which drivers are changing ROE.
* Compare similar companies within an industry.
* Monitor management actions (cost control, asset use, capital structure).

Always pair DuPont findings with industry context, trend analysis, and qualitative information about business strategy and risk.