Introduction : DuPont Analysis
Calculation of return of equity using the DuPont analysis:
This model is used all around the world and serves as the basis for components that make a return on equity.
There are three components in the calculation of return on equity, such as net profit margin, asset turnover, and equity multiplier. By understanding and analyzing each component individually, the sources of a company’s return on equity can be calculated.
• Net profit margin
The company desires for higher net profit margin. Profit margin standard varies from industry to industry.
The calculation is as follows:
Net profit margin = Net Income/ Revenue.
• Asset turnover
The asset turnover ratio measures of how effectively a company converts into sales. It is calculated as follows:
Asset turnover = Revenue/Assets
The asset turnover ratio tends to be inversely related to the net profit margin; that is, the higher the net profit margin, the lower would be the asset turnover ratio. The consequences is that the investor can compare companies using different models (low profit, high volume-based businesses, and vice versa, high profit, low volume) to arrive at a conclusion about which one is better.
• Equity multiplier: There are many company does practice to showcase terrible sales and margin on using excessive amount of debt to trigger with attractive return on equity figure. The equity multiplier helps to measure the financial leverage. The investors are keen to know what proportion of the return on equity is the result of debt.
Equity multiplier = Assets/ Shareholders equity.
The formula is,
ROE = Net profit margin * Asset turnover * Equity multiplier
Suppose,
Net profit margin is 14.39%
Asset turnover 1.0455
Equity multiplier 2.0621
Then, the ROE = (0.1439) * (1.0455) * (2.0621)
= 0.3102 or 31.02%
Analysis: The 31.02% return percentage is absolutely fine in any industry. If only net profit margin and asset turnover are calculated, then the ROE is only 15.04%, and the remaining portion of 15.96% is due to debt incurred by the company. This comparable valuation will help investors analyze a company in a more competitive manner.
Frequently Asked Questions (F.A.Q)
What is the DuPont analysis?
This particular analysis is a framework for analyzing the fundamental performance of a company. Analysts from all over the world practice this to compare the operational efficiency of two similar companies in the same industry.
Which industry use DuPont analysis?
The DuPont analysis is commonly used in the financial industry to analyze the performance and efficiency of a company. It is specifically well known and applicable in evaluating the financial health of companies in the manufacturing, retail, and service sectors. This can also be applied in other industries, such as telecommunications, healthcare, and technology.
What are the drawbacks of DuPont analysis?
The DuPont analysis basically use past financial data to evaluate a company’s performance, which may not accurately reflect the current or future financial health of the company.
What is the limitation of DuPont’s analysis?
The analysis does not consider the quality of a company’s earnings. It does not differentiate between sustainable and unsustainable sources of profitability, potentially leading to an inaccurate assessment of a company’s financial health.
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