DUPONT ANALYSIS

1
 What is DuPont Analysis?

In the 1920s, the management at DuPont Corporation

developed a model called DuPont Analysis

DuPont Analysis is a tool that may help us to avoid

misleading conclusions regarding a company’s
profitability.

2
 What is DuPont Analysis?

ROE analysis enables the analyst to understand the source of

superior (or inferior) return by comparison with companies in
similar industries (or between industries)

ROE = (Profit margin) X (Asset turnover) X

(Equity multiplier)

3
 What is DuPont Analysis?

ROE = (Profit margin) X (Asset turnover) X

(Equity multiplier)

ROA = (Profit margin) X (Asset

turnover)
ROE = (Return on Asset) X (Equity
multiplier)

4
 What is DuPont Analysis?
ROE = (Profit margin) X (Asset turnover) X
(Equity multiplier)

• The first two components assess the operations of the

business.

• The larger these components, the more productive the

business is.
• depending on the industry in which the company
operates

• Net Profit Margin and Total Asset Turnover tend to trade off
between each other.

• For example, a machinery manufacturer is likely to generate

a low turnover of assets and require some heavy
investments; thus, this company will probably see a high
profit margin to offset the low turnover.

• On the other hand, a fast food restaurant is likely to see high 5

What is DuPont Analysis?

6
 What is DuPont Analysis?
EXAMPLE

Let’s analyze the Return on Equity of Companies- A

and B. Both the companies are into the electronics
industry and have the same ROE of 45%. The ratios of
the two companies
Ratio
are as follows Company B
Company A
Profit Margin 30% 15%
Asset Turnover 0.5 6
Financial Leverage 3 0.5
ROE 45% 45%

7
 What is DuPont Analysis?
ROE = (Profit margin) X (Asset turnover) X (Equity multiplier)
A = 30% x 0.5 X 3 = 45%
B = 15% x 6 X 0.5 = 45%
B = 15% x 6 x 3 = 270%

• Even though both companies have the same ROE, however,

the operations of the companies are totally different.

• Company A is able to generate higher sales while maintaining

a lower cost of goods which can be seen from its high-profit
margin.

• On the other hand, company B is selling its products at a lower

margin but having very high Asset Turnover Ratio indicating
that the company is making a large number of sales.

• Moreover, company B seems less risky since its Financial

Leverage is very low.

• Thus this Analysis helps compare similar companies with

similar ratios. It will help investors to measure the risk 8
 What is DuPont Analysis?
EXAMPLE 2
• Julie, Inc. and Joseph, Inc. are two companies in shoe-making
business owned by JJ, Inc.
• They manufacture and market shoes for women and men
respectively.
• both the companies have earned a return on equity of 15%.

Ratio Julie Joseph

Profit Margin 7.5% 10%
Asset Turnover 2 1
Financial Leverage 1 1.5
ROE 15% 15%

9
 What is DuPont Analysis?
ROE = (Profit margin) X (Asset turnover) X (Equity multiplier)
Julie = 7.5% x 2 X 1 = 15%
Joseph = 10% x 1 X 1.5 = 15%
• Even though both companies have the same ROE, however, the
operations of the companies are sane different.

• While Joseph, Inc. has higher net profit margin, its ability to use its
assets to generate sales is average. However, it has made up for it by
higher use of debt in its capital structure.

• The director suggests that board should carry out a detailed

profitability and market positioning study of Julie, Inc. to improve its
profit margin

• while the management of Joseph, Inc. is asked to come up with means

to improve its use of assets either by divesting from redundant assets
or making efforts to increase its sales.

• The company's financial analyst is asked to review the capital

structure of both companies to identify whether Julie, Inc. should be
using more debt. 10
 Limitations/Drawbacks

Although DuPont has many advantages as stated above, but

everything has its own disadvantages also.

•This analysis uses accounting data from the financial statement

in its analysis which can be manipulated by the management to
hide discrepancies.

•It is only useful for comparison between the companies under

the same industry.

11
Can DuPont analysis be applied on a zero debt
company?

•Whether this analysis is also done on a debt free company?

•Whether this analysis will have the same usefulness for a debt
free company or not?

•Yes

•DuPont Analysis is equally useful when analysing a debt free

company.

•The above formula remains the same, with just one exception-
the financial leverage component is taken as 1 and the rest
remains the same.

12
 Bottom-line

we need to check whether the increase in company’s ROE is due

to increase in Net Profit Margin or Asset Turnover Ratio (which
is a good sign) or only due to Leverage (which is an alarming
signal).

13
 Expanded DuPont ROE Analysis
• The DuPont equation can be further decomposed to have
an even deeper insight where the net profit margin is
broken down into EBIT Margin, Tax Burden, and Interest
Burden.
• DuPont decomposition of return on equity (ROE) identifies
the drivers of a company’s ROE in terms of EBIT margin,
interest burden, tax burden, total asset turnover ratio and
financial leverage ratio.

14
 Expanded DuPont ROE Analysis

The DuPont equation can be further decomposed to have an even

deeper insight where the net profit margin is broken down into
EBIT Margin, Tax Burden, and Interest Burden.

ROE = (Profit margin) X (Asset turnover) X (Equity multiplier)

Profit margin = (Tax Burden) X (Interest Burden) X (EBIT

Margin)

ROE = (Tax Burden) X (Interest Burden)X (EBIT Margin) × Asset Turnover ×

Financial Leverage

15
 Breakup of Net profit margin

1. Tax burden

•Tax burden in DuPont analysis is the ratio of a company’s net

income to its earnings before taxes.

•It shows the proportion of earnings before taxes (EBT) that’s left
after income tax charge.

•A high tax burden means that the company is keeping more of

its pretax income which will result in higher ROE and vice versa.

16
 Breakup of Net profit margin

2. Interest burden

•Interest burden is the ratio of earnings before taxes (EBT) to

earnings before interest and taxes (EBIT)

•It shows the percentage of EBIT left over after deduction of

interest expense.
•
•In order to achieve a high ROE, a company must reduce its
interest expense such that the EBT/EBIT ratio is high.

17
 Breakup of Net profit margin

3. EBIT margin

•EBIT margin (also called operating margin) is the ratio of

earnings before interest and taxes (EBIT) to net revenue or sales.

•It is a measure of operating performance i.e. profitability

without considering the capital structure and tax environment
impact.

•To achieve a high ROE, EBIT margin must be increased.

18
 Solve the Case 2
The DuPont Method of Financial Analysis
Airline Profitability Analysis

19
 Q1- What is the Du Pont Method? That is, how
does it differ from the more familiar ratio analysis

• The Du Pont method of financial analyses expresses the

interrelationships among ratio categories.
• That is shown as being made up of ratios from three
different categories
• Profitability, asset management debt management and

20
Q2- Using the Du Pont method, calculate the profit margin,
asset turnover, return on asset and return on equity using DU
Pont framework for each of the air line

21
Q2- Using the Du Pont method, calculate the profit margin,
asset turnover, return on asset and return on equity using DU
Pont framework for each of the air line

22
Q2- Using the Du Pont method, calculate the profit margin,
asset turnover, return on asset and return on equity using DU
Pont framework for each of the air line

23
Q2- Using the Du Pont method, calculate the profit margin,
asset turnover, return on asset and return on equity using DU
Pont framework for each of the air line

24
Q2- Using the Du Pont method, calculate the profit margin,
asset turnover, return on asset and return on equity using DU
Pont framework for each of the air line

25
Q2- Using the Du Pont method, calculate the profit margin,
asset turnover, return on asset and return on equity using DU
Pont framework for each of the air line

26
 Q3- Evaluate the results in terms of the
determinants of ROE

• The case of Airline E is interesting

• It is the most profitable air line with 91% ROE
• But the most profitable airline is not always the best
• These higher values or ROE just because of higher Leverage and
it makes this company more risker
• If we will compare Airline A and B
• Airline A has higher profit margin
• but B’s turnover is higher,
• the ROA of B is higher
• A’s ROE is higher due to higher leverage
27
 Q3- Evaluate the results in terms of the
determinants of ROE cont..

• The case of Airline B and C

• Airline C has lower profit margin but better in terms of high
asset turnover and ROA.
• B and C are good candidates to compare
• In case of D and F, both have very low ROA and less
ROE as compare to company B and C
• The company D is worse in case of asset turnover
• The company F has Lower Profit margin and asset
turnover and higher leverage

28
 Q4- Robert Willams wondered if an airline’s revenue could be
increased simply by increasing its yield (price per passenger
mile). Using Figure 2 as a frame of reference what do you think?

• If the airline increase the price?

• Load factor

29
 Q5- Does the Du Pont method seem relevant for the airline
industry? Why or why not?

Q6- How are financial ratios assessed? That is, how is the
information gained from financial ratio analysis evaluated in
order to provide the most useful information?

You have already studied these methods

30
 Q7- In terms of a time frame, is there a probable minimum
number of years or periods which would maximize the usefulness
of ratio analysis, particularly the Du Pont method?

 Period?
 Other ratios

31