DuPont Analysis: The DuPont Formula

Plus How to Calculate and Use It

By
MARSHALL HARGRAVE
Updated August 14, 2023

Investopedia / Theresa Chiechi

What Is the DuPont Analysis?

The DuPont analysis is a framework for analyzing fundamental performance
popularized by the DuPont Corporation. DuPont analysis is a useful
technique used to decompose the different drivers of return on equity (ROE).
The decomposition of ROE allows investors to focus on the key metrics of
financial performance individually to identify strengths and weaknesses.

There are two versions of the tool—one which accounts for decomposition in
three steps while the other does so in five steps.

KEY TAKEAWAYS

 The DuPont analysis is a framework for analyzing fundamental

performance originally popularized by the DuPont Corporation.
 The formula was developed in 1914 by F. Donaldson Brown, an
employee of the DuPont Corporation.
 DuPont analysis is a useful technique used to decompose the different
drivers of return on equity.
 An investor can use analysis tools like this to compare the operational
efficiency of two similar firms.
 Managers can use DuPont analysis to identify strengths or weaknesses
that should be addressed.

Understanding the DuPont Analysis

The DuPont analysis is a formula used to track a company's financial
performance. It was developed in 1914 by F. Donaldson Brown, who worked
for the DuPont Corporation. His formula incorporates earnings, investment,
and working capital together into a single figure that he called return on
investment (ROI). It became a standard measure for all DuPont departments
and was adopted by other companies.

A DuPont analysis is used to evaluate the component parts of a company's

ROE. This allows an investor to determine what financial activities contribute
the most to the changes in ROE. An investor can use tools like this to
compare the operational efficiency of two similar firms. Managers can use
DuPont analysis to identify strengths or weaknesses that should be
addressed.

There are three major financial metrics that drive ROE:

 Operating efficiency, which is represented by net profit margin or net

income divided by total sales or revenue
 Asset use efficiency, which is measured by the asset turnover ratio
 Financial leverage, a metric that is measured by the equity multiplier,
which is equal to average assets divided by average equity

Formula and Calculation of DuPont Analysis

The DuPont analysis is an expanded return on equity formula, calculated by
multiplying the net profit margin by the asset turnover by the equity
multiplier.

DuPont Analysis=Net Profit Margin×AT×EM

The DuPont analysis is also known as the DuPont identity or DuPont model.

DuPont Analysis Components

DuPont analysis breaks ROE into its constituent components to determine
which of these factors are most responsible for changes in ROE.

Net Profit Margin

The net profit margin is the ratio of bottom line profits compared to total
revenue or total sales. This is one of the most basic measures of profitability.

One way to think about the net margin is to imagine a store that sells a single
product for $1.00. After the costs associated with buying inventory,
maintaining a location, paying employees, taxes, interest, and other expenses,
the store owner keeps $0.15 in profit from each unit sold. That means the
owner's profit margin is 15%, which can be calculated as follows:

Profit Margin=Net Income/Revenue=$0.15/$1.00=15%

The profit margin can be improved if costs for the owner were reduced or if
prices were raised, which can have a large impact on ROE. This is one of the
reasons that a company's stock will experience high levels of volatility when
management makes a change to its guidance for future margins, costs, and
prices.

Asset Turnover Ratio

The asset turnover ratio measures how efficiently a company uses its assets to
generate revenue. Imagine a company had $100 of assets, and it made $1,000
of total revenue last year. The assets generated 10 times their value in total
revenue, which is the same as the asset turnover ratio and can be calculated
as follows:

Asset Turnover Ratio=Revenue/Average Assets=$1,000/$100=10

A normal asset turnover ratio will vary from one industry group to another.
For example, a discount retailer or grocery store will generate a lot of revenue
from its assets with a small margin, which will make the asset turnover ratio
very large. On the other hand, a utility company owns very expensive fixed
assets relative to its revenue, which will result in an asset turnover ratio that
is much lower than that of a retail firm.

The ratio can be helpful when comparing two companies that are very
similar. Because average assets include components like inventory, changes
in this ratio can signal that sales are slowing down or speeding up earlier
than they would show up in other financial measures. If a company's asset
turnover rises, its ROE improves.

Financial Leverage

Financial leverage, or the equity multiplier, is an indirect analysis of a

company's use of debt to finance its assets. Assume a company has $1,000 of
assets and $250 of owner's equity. The balance sheet equation will tell you
that the company also has $750 in debt (assets - liabilities = equity). If the
company borrows more to purchase assets, the ratio will continue to rise. The
accounts used to calculate financial leverage are both on the balance sheet, so
analysts will divide average assets by average equity rather than the balance
at the end of the period, as follows:

Financial Leverage=Average Assets/Average Equity=$1,000/$250=4

Most companies should use debt with equity to fund operations and growth.
Not using any leverage could put the company at a disadvantage compared
with its peers. However, using too much debt in order to increase the
financial leverage ratio—and therefore increase ROE—can create
disproportionate risks.

A point to note, though, is that some companies use balance sheet averages
when one of the components is an income statement metric. In the case noted
above, no averaging is necessary as the equation takes balance sheet/balance
sheet figures into account.

DuPont Analysis vs. Return on Equity (ROE)

The return on equity metric is net income divided by shareholders’ equity.
The DuPont analysis is still the ROE, just an expanded version. The ROE
calculation alone reveals how well a company utilizes capital from
shareholders.
With a DuPont analysis, investors and analysts can dig into what drives
changes in ROE, or why an ROE is considered high or low. That is, a DuPont
analysis can help deduce whether its profitability, use of assets, or debt that’s
driving ROE.

Drawbacks of Using DuPont Analysis

The biggest drawback of the DuPont analysis is that, while expansive, it still
relies on accounting equations and data that can be manipulated. Plus, even
with its comprehensiveness, the DuPont analysis lacks context as to why the
individual ratios are high or low, or even whether they should be considered
high or low at all.

Example of DuPont Analysis

Here's a hypothetical example to show how the DuPont analysis works. Let's
say an investor has been watching two similar companies, SuperCo and Gear
Inc. Both of these companies have improved their return on equity compared
to the rest of their peer group, which could be a good thing if the two
companies make better use of assets or improving profit margins.

In order to decide which company is a better opportunity, the investor

decides to use DuPont analysis to determine what each company does to
improve its ROE and whether that improvement is sustainable.

As you can see in the table, SuperCo improved its profit margins by
increasing net income and reducing its total assets. SuperCo's changes
improved its profit margin and asset turnover. The investor can deduce that
SuperCo also reduced some of its debt since average equity remained the
same.

Looking closely at Gear, the investor can see that the entire change in ROE
was due to an increase in financial leverage. This means the company
borrowed more money, which reduced average equity. The investor is
concerned because the additional debt didn't change the company's net
income, revenue, or profit margin. As such, the leverage may not add any
real value to the firm.

Real-World Example

Now let's consider Walmart (WMT). For the fiscal year ending Jan. 31, 2022,
the company reported:

 Net income over the trailing 12 months (TTM) of $13.7 billion

 Revenue of $572.8 billion
 Assets of $244.9 billion
 Shareholders' equity of $83.3 billion5

So from these figures, we can use the information above to deduce that the
company had the following:

 Profit margin of 2.4% or $4.87 billion/$572.8 billion

 Asset turnover of 2.34 or $572.8 billion/$244.9 billion
 Financial leverage (or equity multiplier) is 2.94 or $244.9 billion/$83.3
billion

According to these figures, Walmart's return on equity (ROE) for the fiscal
year was 16.5% (or 2.4% x 2.34 x 2.94).

What Does DuPont Analysis Tell You?

DuPont analysis is a useful technique used to decompose the different
drivers of return on equity for a business. This allows an investor to
determine what financial activities are contributing the most to the changes
in ROE. An investor can use an analysis like this to compare the operational
efficiency of two similar firms.
What Is the Difference Between 3-Step and 5-Step DuPont
Analysis?
There are two versions of DuPont analysis, one utilizing decomposition of
ROE via three steps and another utilizing five steps. The three-step equation
breaks up ROE into three very important components:

The five-step version instead is:

Why Is It Called DuPont Analysis?

A DuPont employee by the name of F. Donaldson Brown developed a
formula in 1914 that was used by the company as an internal management
tool to better understand where its operating efficiency was coming from and
where it was falling short. By breaking down ROE into a more complex
equation, DuPont analysis shows the causes of shifts in this number.1

What Are Some Limitations of Using DuPont analysis?

While the DuPont analysis can be a very helpful tool for managers, analysts,
and investors, it is not without its weaknesses. Its expansive nature means
that it requires several inputs. As with any calculation, the results are only as
good as the accuracy of the inputs.

This tool utilizes data from a company's income statement and balance sheet,
some of which may not be entirely accurate. Even if the data used for
calculations are reliable, there are still additional potential problems, such as
the difficulty of determining the relative values of ratios as good or bad
compared to industry norms.

Seasonal factors, depending on the industry, can also be an important

consideration since these factors can distort ratios. For instance, some
companies always carry a higher level of inventory at certain times of the
year. Different accounting practices between companies can also make
accurate comparisons difficult.

The Bottom Line

DuPont analysis is a useful tool for evaluating the components that make up
a company's ROI calculation. Whether you're an analyst, investor, or
manager, you can use DuPont analysis to spot the causes for a shift in ROI,
track a company's financial performance, and gather data to make informed
decisions. Just keep in mind the limitations of this formula as it relates to the
quality of the inputs.