DuPont Analysis
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Insights on the above DuPont Analysis Calculation
What does DuPont analysis do?
The DuPont analysis is a framework for analyzing fundamental performance. It 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.
DuPont Analysis vs. Return on Equity
The return on equity metric is net income divided by shareholders’ equity. Dupont analysis can help deduce whether its profitability, use of assets, or debt that’s driving ROE.
Components of ROE
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.
Limitations of Using DuPont analysis
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.
