DuPont Analysis: The DuPont Formula Plus How to Calculate and Use It (2024)

What Is the DuPont Analysis?

The DuPont analysis is a framework for analyzing fundamental performance developed decades ago at DuPont de Nemours, Inc. DuPont analysis breaks out the different drivers of return on equity (ROE), allowing company managers and investors to focus on them individually to identify strengths and weaknesses. There are two versions of the tool—one that involves three steps and another that uses five.

Understanding the DuPont Analysis

The DuPont analysis is a formula used to evaluate a company's financial performance based on its return on equity (ROE). By most accounts, it was devised in 1919 by a DuPont executive.

A company's ROE is calculated by dividing its net income by shareholders' equity. It reveals how well a company utilizes capital from shareholders.

A DuPont analysis goes a step further and allows an investor to determine which financial activities contribute the most to the changes in ROE. An investor can also use a DuPont analysis to compare the operational efficiency of two similar companies, while company managers can use it 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.

$\begin{aligned} &\text{DuPont Analysis} = \text{Net Profit Margin} \times \text{AT} \times \text{EM} \\ &\textbf{where:}\\ &\text{Net Profit Margin} = \frac{ \text{Net Income} }{ \text{Revenue} } \\ &\text{AT} = \text{Asset turnover} \\ &\text{Asset Turnover} = \frac{ \text{Sales} }{ \text{Average Total Assets} } \\ &\text{EM} = \text{Equity multiplier} \\ &\text{Equity Multiplier} = \frac{ \text{Average Total Assets} }{ \text{Average Shareholders' Equity} } \\ \end{aligned}$​DuPontAnalysis=NetProfitMargin×AT×EMwhere:NetProfitMargin=RevenueNetIncome​AT=AssetturnoverAssetTurnover=AverageTotalAssetsSales​EM=EquitymultiplierEquityMultiplier=AverageShareholders’EquityAverageTotalAssets​​

DuPont Analysis Components

As mentioned, a 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 certain product for $1. After the costs associated with buying inventory, maintaining a location, and 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:

$\begin{aligned} &\text{Profit Margin} = \frac{ \text{Net Income} }{ \text{Revenue} } = \frac{ \$0.15 }{ \$1.00 } = 15\% \\ \end{aligned}$​ProfitMargin=RevenueNetIncome​=$1.00$0.15​=15%​

The profit margin could be improved if costs for the owner were reduced or if prices on the product were raised, which could 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 in 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:

$\begin{aligned} &\text{Asset Turnover Ratio} = \frac{ \text{Revenue} }{ \text{Average Assets} } = \frac{ \$1,000 }{ \$100 } = 10 \\ \end{aligned}$​AssetTurnoverRatio=AverageAssetsRevenue​=$100$1,000​=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 operate in the same industry. 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 in 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:

$\begin{aligned} &\text{Financial Leverage} = \frac{ \text{Average Assets} }{ \text{Average Equity} } = \frac{ \$1,000 }{ \$250 } = 4 \\ \end{aligned}$​FinancialLeverage=AverageEquityAverageAssets​=$250$1,000​=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 illustrated above, no averaging is necessary as the equation takes balance sheet/balance sheet figures into account.

Drawbacks of a DuPont Analysis

The biggest drawback of the DuPont analysis is that 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 a 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 has done 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.

A Real-World Example

Now let's consider Walmart (WMT). For the fiscal year ending Jan. 31, 2024, the company reported:

• Net income over the trailing 12 months (TTM) of $16.3 billion
• Revenue of $648.1 billion
• Assets of $252.4 billion
• Shareholders' equity of $80.9 billion

Based on these figures, we can deduce that the company had the following:

• Profit margin of 2.5% or $16.3 billion/$648.1 billion
• Asset turnover of 2.57 or $648.1 billion/$252.4 billion
• Financial leverage (or equity multiplier) of 3.12 or $252.4 billion/$80.9 billion

Using a DuPont analysis then, Walmart's return on equity (ROE) for the fiscal year was 20.0% (or 2.5% x 2.57 x 3.12).

The Bottom Line

DuPont analysis is a useful tool for evaluating the components that make up a company's ROE calculation. Whether you're a stock analyst, an investor, or a manager, you can use a DuPont analysis to understand what drives a company's ROE, spot the causes for any shift in its ROE, and compare its financial performance to that of its competitors. Just keep in mind the limitations of this formula as it relates to the quality of the inputs.