Question

Do you see any benefits that stock analysts can have from using DuPont as a calculation for ROE for a given firm? Can you find an example of this in the news?

Answer 1

DuPont analysis is a helpful tool for analysis that investors can use to make more informed choices regarding their equity holdings. The main advantage of DuPont analysis is it provides fuller picture of a company's overall financial health and performance . The only disadvantage of the DuPont model is that it relies more on accounting data from a company's financial statements, some of which can be manipulated by companies.

DuPont analysis is an equity evaluation approach that uses financial and leverage ratios that expand the profitability ratio of return on equity (ROE) into a more detailed and comprehensive measure. In addition to indicating the return on investment (ROI) for shareholders, DuPont analysis also factors in three important performance elements: profitability measured by profit margin, operational efficiency measured by asset utilization (specifically asset turnover) and financial leverage measured by the assets/equity multiplier. If ROE is higher due to improved operational efficiency or utilization of assets, this is commonly interpreted favorably by analysts. However, if the ROE for investors only improves due to a company using increased financial leverage, then the increased equity returns are not actually a result of increased profits, and the company may be overextending itself financially, making it a riskier investment.

The DuPont analysis model provides accurate assessment of changes in a company's ROE by focusing on the various means that a company has to increase the ROE figures. The means include the profit margin, asset utilization and financial leverage. A company can improve any or all of these elements to increase value and returns to shareholders through its management of costs, choices of financing and usage of assets. DuPont analysis helps investors by highlighting the source of increased or decreased equity returns.