DuPont analysis

DuPont analysis breaks return on equity down into three separate drivers, so an investor can see exactly what's producing a company's return rather than just the single combined number. It was developed inside the DuPont chemical company in the early twentieth century as an internal management tool and has since become a standard part of fundamental analysis.

The formula is:

Net margin measures how much profit the company keeps from each dollar of revenue. Asset turnover measures how efficiently the company uses its assets to generate revenue. Financial leverage measures how much the company relies on debt relative to equity to fund its assets. Multiplying the three together reproduces return on equity, but breaking it apart this way shows whether that return is coming from strong profitability, efficient use of assets, heavy use of debt, or some combination of the three.

The distinction matters because two companies can post the same return on equity for very different reasons. One company might earn it through high margins and efficient operations, a durable source of return. Another might reach the same number mainly through leverage, borrowing heavily to boost the return on a smaller equity base, which carries more risk and can unwind quickly if earnings weaken or debt gets more expensive. DuPont analysis lets an investor tell those two stories apart instead of treating an identical return on equity figure as equally attractive in both cases.