can somebody pls explain me the du pont model
CA LOVELY ARORA
(C.A. B.Com (H) Graduate)
(2151 Points)
Replied 03 February 2010
ROE = (Profit margin)*(Asset turnover)*(Equity multiplier) = (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
The Du Pont identity breaks down Return on Equity (that is, the return to equity that investors have contributed to the firm) into three distinct elements. This analysis enables the analyst to understand the source of superior (or inferior) return by comparison with companies in similar industries (or between industries).
The Du Pont identity, however, is less useful for some industries, such as investment banking, that do not use certain concepts or for which the concepts are less meaningful. Variations may be used in certain industries, as long as they also respect the underlying structure of the Du Pont identity.
Du Pont analysis relies upon the accounting identity, that is, a statement (formula) that is by definition true.
Certain types of retail establishments, particularly stores, may have very low profit margins on sales, and relatively moderate leverage.In contrast, though, groceries may have very high turnover, selling a significant multiple of their assets per year. The ROE of such firms may be particularly dependent on performance of this metric, and hence asset turnover may be studied extremely carefully for signs of under-, or, over-performance. For example, same store sales of many retailers is considered important as an indication that the firm is deriving greater profits from existing stores (rather than showing improved performance by continually opening new stores).
Other industries, such as fashion, may derive a substantial portion of similar companies.
The return on investment (ROI) ratio developed by Du Pont for its own use is now used by many firms to evaluate how effectively assets are used. It measures the combined effects of profit margins and asset turnover.[1]
The return on equity (ROE) ratio is a measure of the rate of return to stockholders.[2] Decomposing the ROE into various factors influencing company performance is often called the Du Pont system.[3]
This decomposition presents various ratios used in fundamental analysis.
ROE can also be stated as:[4]
Profit margin is (Net profit ÷ Sales), so the ROE equation can be restated:
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