What is DuPont analysis?
Variation on calculation of return on equity (ROE), which uses a gross value for assets (ignoring accumulated depreciation) not net value for assets so as to come up with higher ROE is called DuPoint analysis. The modification was developed by DuPoint Corporation in 1920’s.
ROE = Profit Margin x Asset Turnover x Equity Multiplier
Profit Margin = Measure of operating efficiency
Asset Turnover = Measures asset use efficiency
Equity Multiplier = Measures amount of financial leverage used by company
Reason behind method use
Using the method, managers gain most out of the assets placed with them unlike in case of net asset values where ROE comes out lower due to accumulated depreciation.
Just using basic ROE analysis may give out confusing results, but DuPoint method helps an investor to conclude the basis due to which the total ROE number changed.
If there is an increase in the profit margin or asset turnover portions of the ROE, it means good company is in hands of good managers. Nevertheless, if ROE comes out higher as company has borrowed more money (higher financial leverage), this designates that the company is a risky investment.