Application of Dupont analysis of return on equity

Dupont system of analysis (1)

  • Used to analyze return on equity (2) (ROE)
  • Analyst can see the impact of
    • Leverage 
    • Profit margins
    • Turnover on shareholder returns
  • Two variants 
    • Original three-part approach (3)
      • Break down a very important ratio into 3 key components
      • Most important equation in ratio analysis
      • If ROE is low, the reason should be 
        • Poor profit margin (weak operation)
        • Poor asset turnover (weak investment)
        • Too little leverage (weak financing)
    • Extended five-part system  (4)

Original approach 

  • ROE: 

Extended Dupont equation (4)

  • Take net profit margin and breaks down further
  • Tax burden
  • Interest burden
    • Leverage rise when interest burden rise
  • EBIT margin