DuPont Analysis: Explanation, Components, Calculation

DuPont analysis is one of the key financial metrics that breaks down and understands the financial profitability of a company. The primary goal of DuPont analysis is to provide a deeper understanding of what drives a company's profitability by examining various financial ratios and their interrelationships. Let us understand how DuPont Analysis works through real-life examples.

Table of Contents

• What is DuPont Analysis?
• DuPont Analysis Formula
• Stages of DuPont Analysis
• DuPont Method - ROE Calculation
• Key Takeaways - DuPont Analysis

What is DuPont Analysis?

DuPont analysis is a financial performance measurement framework used to break down and understand the financial profitability of a company. It breaks down a company's return on equity (ROE) into smaller chunks, allowing identification of the critical factors that contribute to that profitability. 

By breaking ROE into different ratios, such as net margin, asset turnover, and financial leverage, DuPont analysis provides a detailed view of how profits or losses are generated in the company.

The DuPont Corporation developed the DuPont model in the early 20th century. The primary goal of DuPont analysis is to provide a deeper understanding of what is driving a company's ROE by examining various financial ratios and their interrelationships. 

DuPont Analysis Formula

The DuPont formula can be expressed as -

ROE = Net Profit Margin × Asset Turnover × Financial Leverage

Let us check out the examples of Apple Inc. and Samsung Electronics and conduct a DuPont Analysis to check out their profitability levels for FY 2022 - 2023.

Stages of DuPont Analysis 

In DuPont analysis, ROE is divided into various parts to determine and decide which particular part or factor is responsible for the changes felt in ROE.

Net Profit Margin

Net profit margins refer to the ratio of bottom-line profits compared to total revenue or sales a company generates. Net profit margin is one of the primary measures of a company's profitability or profits. 

Net Profit Margin = Revenue ÷ Net Income 

A company with a high net profit margin is generally considered a more profitable investment than a company with a low net profit margin. High net profit margins indicate that a company can generate considerable profit from sales.

Let us take the case of Apple and Samsung. In 2022-23, Apple had a net profit margin of 25.31%, while Samsung had a net profit margin of 12.8%. For every dollar of revenue, Apple kept 25.31 cents as profit, while Samsung kept 12.8 cents as profit.

In the case of Apple and Samsung, Apple's higher net profit margin suggests that it is more profitable than Samsung, making it a more attractive investment for investors looking for companies with high growth potential.

Asset Turnover Ratio

The asset turnover ratio refers to how a company uses its assets efficiently to generate income or revenue. The asset turnover ratio can be calculated as: 

Asset Turnover Ratio = Net Sales ÷ Average Total Assets 

Asset turnover ratios can vary from sector to sector as not all investments can return as much as others. 

Let us understand this with the previous example -  Apple's asset turnover ratio for the FY 2022-23 was 1.09. This means that Apple generated $1.09 in sales for every dollar of assets it held. On the other hand, Samsung's asset turnover ratio was 0.57, meaning every dollar of Samsung's assets generated $0.57 in sales.

What does this mean?

In this case, Apple's asset turnover ratio of 1.09 is significantly higher than Samsung's asset turnover ratio of 0.57. These results indicate that Apple generated more sales per dollar of assets than Samsung, and it could use its assets more effectively to generate profits.

Equity Multiplier (EM) or Financial Leverage

Financial leverage, or gearing, refers to using debt or borrowed capital to finance a company's assets or investments. It is a strategy employed by firms to amplify their potential ROE.

Financial leverages are calculated using balance sheets, allowing analysts to divide average assets by average equity rather than the total balance at the end of the trading season. 

Financial leverage is calculated as follows: 

Financial Leverage = Company's Total Assets ÷ Total Stockholders' Equity

Most companies use financial leverage to carry out projects and investments and finance their business operations, especially when They are accompanied by capital. Using leverage helps a company grow faster and catch up with its competitors since it would have more money than it would have possessed to carry out a project.  

Continuing with our above example. Apple's equity multiplier in FY 2022-23 was 5.52, while that of Samsung Electronics Co., Ltd. in FY 2022-2023 was 4.06. The financial leverage of Apple is higher than that of Samsung, suggesting that Apple is using a significant amount of debt to finance its assets, resulting in higher profitability.

If you want to learn more about DuPont analysis in a more interesting way. consider watching these videos from experts.

Source - The Finance Storyteller

DuPont Method - ROE Calculation

Based on the given data, let's apply the DuPont Analysis method to calculate and compare the ROE of Apple and Samsung.

A higher DuPont analysis score indicates that the company is more profitable, in this example, Apple.

However, it is important to note that a higher DuPont analysis score is not always the best indicator of profitability. It is just a diagnostic tool. Companies can manipulate their DuPont analysis score by taking on more debt or by cutting costs in ways that may not be sustainable in the long term.

Key Takeaways - DuPont Analysis 

• The DuPont method is based on a company's net margin, asset rotation and financial leverage. 
• Net profit margin measures how efficiently a company converts its sales into profits.
• Asset turnover measures how efficiently a company uses its assets to generate sales.
• Financial leverage measures how much debt a company uses to finance its operations.
• DuPont analysis is just one of many tools used to evaluate a company's financial performance, and a higher DuPont analysis score generally indicates a higher level of profitability.