17 August 2010
DuPont Analysis, or DuPont Identity, offers a more detailed analysis when evaluating the return-on-equity (ROE) of a company. The measure was conceived by the DuPont Corporation in the 1920s to evaluate profitability, operating efficiency and leverage, all within the ROE analysis. Many financial analysts believe that the DuPont Analysis provides an excellent snapshot of a company’s financial strength.
The return-on-equity measure is widely used by investors to determine how efficiently a company is using its money. There are two ways of calculating ROE: the traditional approach and the DuPont formula. Under the traditional formula, the company’s net profit after taxes for the past 12 months is divided by shareholder equity. As this approach fails to account for the effect of borrowed funds, the DuPont Analysis formula was developed to link the use of debt to the outcome.
The idea behind the more detailed DuPont Analysis is that companies that demonstrate a higher ROE with minimal debt can expand without large capital outlays, allowing its owners to access cash generated by the business for consumption or re-investment. In other words, two companies can have the same ROE, yet one may be much more efficient
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