Why is the Dupont identity a valuable tool for analyzing the performance of a firm?

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Before we jump to why the DuPont Identity is a valuable tool to analyse the performance of a firm, we need to first understand what it actually is.

The DuPont identity is an equation that measures and highlights the company's ROE( Return on Equity) by breaking the ROE into 3 ratios, namely the profit margin, total asset turnover and equity multiplier.

ROE means the profitability of the company in relation to its net assets( assets - liabilities).

Profit margin shows the net profit as a percentage of the revenue.

Asset turnover shows the efficiency in the usage of assets of the company to generate sales revenue.

Equity multiplier shows total assets as a proportion of shareholders' equity.

Therefore, the ROE is now equal to (net income / sales) x (revenue / total assets) x (total assets / shareholder equity).

This clearly shows why the identity is very important for financial analysis. It takes both sales revenue and profit margin for comparison with net assets which again is compared with the equity of the company. Thus a company's sales revenue or profit margin may increase but the ROE will fall if the other metrics are not healthy. This is why this equation assumes such importance in the equity market.

jeff jeffy answered 1 year ago

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