DuPont Analysis and Return on Equity (ROE)

Du Pont analysis helps integrate financial ratios through ROE. Return on equity, similarly to its importance on invested capital, is essentially the return made on your equity. The one measure helps determine profitability through profit margin, asset and inventory efficiency through asset turnover, and leverage. The caveat with the analysis is the combination of the P&L and balance sheet ratios. This can created distorted outputs as it is difficult to calculate relative values vs peers. To note, I typically choose ROE over ROIC, but return on invested capital will include ownership interest, inclusive of debt. Nevertheless, the following is the decomposition ROE:

1. ROE = Net Income/ Average OE

2. ROE = (NI/ Average A) * (Average A / Average OE); if you cross multiply you get back to NI/OE
          Therefore: ROE = ROA * Financial Leverage

3. ROE = (NI / Revenue) * (Revenue / A) * (A/OE); if you cross multiply you get back to NI/OE
          Therefore: ROE = ROS * Asset Turnover * Asset Leverage
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4. ROE = (NI/EBT) * (EBT/EBT) * (EBIT/Revenue) * (Revenue/A) * (A/OE)
          Therefore: ROE = Tax Burden * Interest Burden * EBIT Margin * “A” turnover * Leverage
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