DuPont System of Analysis

I.  Objective: Find out why a company’s profitability, as measured by ROA and ROE, is higher or lower than the industry average ROA or ROE or last year’s company ROA or ROE.

  1. Example: Kohls – company wanted to grow fast, and was able to grow ever faster than its planned growth rate because its profitability as measured by ROE was higher than expected
  2. DuPont formula: ROA = Net Profit Margin x Total Asset Turnover
  3. Pricing and expense control captured by Net Profit Margin
  4. Efficiency of asset use captured by Total Asset Turnover
  5. Company’s over- or underperformance on ROA is due to one or both of these causes, or “drivers”
  6. Modified DuPont formula:
    ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage Multiplier
  7. Financial Leverage Multiplier, or “Equity Multiplier” as some call it, is really a debt ratio
  8. More assets financed with debt mean less assets financed with equity, so higher this number is, the greater the use of financial leverage
  9. Company can “lever up” ROE by using more debt (up to a point, because interest expense starts driving down Net Profit Margin)
  10. Company’s over- or underperformance on ROE is due to one of three causes, or “drivers”
  11. NPM
  12. TAT
  13. FLM
  14. Compare company to itself over time and to industry for most recent year when doing your DuPont analysis of ROE

II.  Example:

  1. Kohls has NPM of 7%, TAT of 2, FLM of 1.5
  2. Department stores industry has NPM of 8%, TAT of 1.5, and FLM of 1.25
  3. Format to show your DuPont analysis:

Company/Industry / ROE / NPM / TAT / FLM
Kohls / 21.0% / 7% / 2 / 1.5
Dept. store industry / 15.0% / 8% / 1.5 / 1.25
  1. Conclusion: Kohls has a much better ROE than its industry because (1) its use of assets is more efficient (it generates more sales per dollar of asset investment) and (2) because it uses more debt financing. Kohls pricing or expense control are inferior to the industry, however, and the use of debt constitutes a greater risk for Kohls because it may not be able to handle the interest payments and principal repayment.