A method of performance measurement that was started by the DuPont Corporation in

the 1920s. With this method, assets are measured at their gross book value rather
than at net book value in order to produce a higher return on equity (ROE). It is also
known as "DuPont identity".
DuPont analysis tells us that ROE is affected by three things:
Operating efficiency, which is measured by profit margin
Asset use efficiency, which is measured by total asset turnover
Financial leverage, which is measured by the equity multiplier

This model was developed to analyse ROE and the effects different business
performance measures have on this ratio. So investors are not looking for large or
small output numbers from this model. Instead, they are looking to analyse what is
causing the current ROE. For instance, if investors are unsatisfied with a low ROE, the
management can use this formula to pinpoint the problem area whether it is a lower
profit margin, asset turnover, or poor financial leveraging.
Once the problem area is found, management can attempt to correct it or address it
with shareholders. Some normal operations lower ROE naturally and are not a reason
for investors to be alarmed. For instance, accelerated depreciation artificially lowers
ROE in the beginning periods. This paper entry can be pointed out with the Dupont
analysis and shouldn't sway an investor's opinion of the company.

High margin industries

Other industries, such as fashion, may derive a substantial portion of their competitive advantage
from selling at a higher margin, rather than higher sales. For high-end fashion brands, increasing
sales without sacrificing margin may be critical. The Du Pont identity allows analysts to determine
which of the elements is dominant in any change of ROE.

High turnover industries

Certain types of retail operations, particularly stores, may have very low profit margins on sales,
and relatively moderate leverage. In contrast, though, groceries may have very high turnover,
selling a significant multiple of their assets per year. The ROE of such firms may be particularly
dependent on performance of this metric, and hence asset turnover may be studied extremely
carefully for signs of under-, or, over-performance. For example, same store sales of many
retailers is considered important as an indication that the firm is deriving greater profits from
existing stores (rather than showing improved performance by continually opening stores).

High leverage industries

Some sectors, such as the financial sector, rely on high leverage to generate acceptable ROE.
Other industries would see high levels of leverage as unacceptably risky. Du Pont analysis enables
third parties that rely primarily on the financial statements to compare leverage among similar
companies.

Let's take a look at Sally's Retailers and Joe's Retailers. Both of these companies
operate in the same apparel industry and have the same return on equity ratio of 45
percent. This model can be used to show the strengths and weaknesses of each
company. Each company has the following ratios:
Ratio
Profit Margin
Total Asset Turnover
Financial Leverage

Sally
30%
0.50
3.0

Joe
15%
6.0
0.50