# DuPont Analysis DuPont analysis breaks return on equity into profit margin, asset turnover, and financial leverage. **The question.** Why is this company's return on equity what it is: margin, asset use, or borrowing? Also known as: Also called the DuPont model, the DuPont formula, or the DuPont identity. ## When to use it - A company's return on equity has moved, or differs from its peers, and the client asks which lever to pull. - Two business units, or an acquirer and a target, report similar returns and you suspect they get there in different ways. - You are screening a set of companies or divisions and want to know where to dig before the detailed work starts. ## When to avoid it - The business is a bank, insurer, or other financial firm. Its balance sheet is the product, so asset turnover and the equity multiplier do not mean what they mean in an industrial company. - Equity is small, negative, or distorted by buybacks and write-offs. ROE then swings or loses meaning, and return on invested capital is the better base. - The question is whether the business earns more than its capital costs. DuPont has no cost of capital in it, so use economic value added. - You have one year of accounts and no peers. A ratio with nothing to compare against does not point anywhere. ## Overview DuPont analysis splits return on equity into three multiplied terms: how much profit each dollar of sales yields, how many dollars of sales each dollar of assets produces, and how many dollars of assets each dollar of equity funds. It supports the choice of where to dig when a company's return differs from a peer's or from its own past: pricing and cost, asset use, or financing. The terms multiply to ROE by definition, so the arithmetic always reconciles and proves nothing about causes. Leverage is the term to watch. A higher equity multiplier raises ROE while making losses more expensive, so identical returns can carry very different risk. ## The three drivers ### Net profit margin Net income per dollar of sales. Pricing, product mix, and the cost of goods and overhead move it. Businesses selling a differentiated product at a premium tend to earn their return here. ### Asset turnover Sales per dollar of average total assets. Inventory, receivables collection, plant utilization, and how much asset the business needs to deliver a dollar of sales move it. Low-margin retail and distribution tend to earn their return here. ### Equity multiplier Average total assets per dollar of average equity, which is a measure of how much of the asset base is funded by debt and other liabilities. Borrowing, buybacks, dividends, and retained profit move it. Raising it raises ROE and makes a bad year more expensive. ## What it is not - A diagnosis. It shows which term differs, and says nothing about why. The reason sits in pricing, operations, or financing, and you find it elsewhere. - A recommendation to add debt. A higher equity multiplier lifts ROE with no change in how the business operates, and it adds risk at the same time. ## The steps 1. **Pull comparable statements.** Collect three or more years for the client and its peers. Use averages of opening and closing balances where you can. Align definitions for leases, one-time items, and year-ends before you compute anything. 2. **Compute the three terms.** Calculate net profit margin, asset turnover, and the equity multiplier for each company and year. Multiply them and check the result against reported ROE. If it does not reconcile, a definition differs, and the comparison cannot be trusted until it is fixed. 3. **Find the term that explains the gap.** Compare each term with the peer set and with the company's own history. Change one term at a time and recompute ROE, to see which accounts for most of the difference. 4. **Go one level down on that term.** If margin differs, use the five-step version to separate tax, interest, and operating margin. If turnover differs, split it into receivables, inventory, and fixed assets. If leverage differs, look at the debt maturity profile and what retained profit and buybacks have done to equity. 5. **Write the findings as questions.** Each gap becomes a hypothesis about pricing, operations, or financing, with the data that would test it. The output is a short list of questions for the next round of interviews and analysis, not a conclusion. ## The formula ROE = net profit margin × asset turnover × equity multiplier Return on equity equals profit per dollar of sales, times sales per dollar of assets, times assets per dollar of equity. The five-step version splits the margin into three terms, so ROE becomes tax burden × interest burden × operating margin × asset turnover × equity multiplier. - Net profit margin: net income ÷ sales. - Asset turnover: sales ÷ average total assets. - Equity multiplier: average total assets ÷ average equity. - Tax burden: net income ÷ pretax income. - Interest burden: pretax income ÷ EBIT. It equals 1.00 for a company with no interest expense. - Operating margin: EBIT ÷ sales. ## In practice Two companies in a portfolio review both show a 15 percent return on equity, and the investor asks whether they are equally good businesses. Put both on sales of 1,000. The retailer earns net income of 30, a margin of 3 percent, on assets of 500, a turnover of 2.0 times, funded by equity of 200, a multiplier of 2.5. So 0.03 × 2.0 × 2.5 = 0.15. The specialty manufacturer earns 120, a margin of 12 percent, on assets of 1,000, a turnover of 1.0, funded by equity of 800, a multiplier of 1.25. So 0.12 × 1.0 × 1.25 = 0.15. The same one-point margin loss costs them different amounts. The retailer's margin falls to 2 percent and ROE drops to 0.02 × 2.0 × 2.5 = 10 percent. The manufacturer's falls to 11 percent and ROE drops to 0.11 × 1.0 × 1.25 = 13.75 percent. The retailer's return depends on thin margins and a good deal of borrowing, so the next questions are pricing discipline and how much debt it can carry. The manufacturer's questions are why 1,000 of assets produces only 1,000 of sales, and whether the equity is working hard enough. ## What you leave with - A table of ROE and its three or five terms for the client and its peers over several years. - The term or terms that explain most of the gap or the change. - A list of hypotheses for why that term differs, each with the data needed to test it. - A statement of how much of the ROE depends on leverage, written next to the risk that leverage carries. ## Failure points ### Stopping at the ratios The decomposition says where the difference sits and not why. A team that presents "asset turnover is low" as the finding has stopped before the analysis starts. ### Leverage mistaken for improvement ROE rises because equity shrank through buybacks or accumulated losses, while margin and turnover are flat. Read on its own, the figure looks like better performance. ### Definitions that do not match One peer capitalizes leases, another reports on a different year-end, a third has a large one-time gain in net income. The terms are then not comparable, and the product will not reconcile to reported ROE. ### Year-end balances in a seasonal business Sales divided by a seasonal peak or trough in assets overstates or understates turnover. Average the balances over the year, or over four quarters. ### A target for each term A manager told to raise asset turnover cuts inventory and loses sales, so margin falls with it. The terms are linked in the business even though they are separate in the formula. The failures above are usually [Commercial Acumen](https://usefulconsultingframeworks.com/your-edge/#commercial): the work was not tied to money, for the client and/or for you. ## Origin Donaldson Brown, an electrical engineer who joined DuPont as a sales representative in 1908, wrote a 1914 report ranking the company's operating departments by their return on invested capital. He split that return into profit as a percentage of sales and the turnover of invested capital. DuPont adopted the measure for its departments, and Brown took it to General Motors in 1921 as vice president of finance. The original formula had two factors and worked on total capital. The three-factor version that ends in return on equity, with the equity multiplier added, and the five-factor version that splits the margin into tax burden, interest burden, and operating margin, are later extensions taught in finance texts. Credit for them is not usually given to one author. ## Further reading - [The Father of ROI: Donaldson Brown](https://www.hagley.org/librarynews/father-roi-donaldson-brown). A short account from the Hagley Library of how Brown developed the measure at DuPont in 1914 and took it to General Motors. Free. - [Donaldson Brown (1885-1965): The power of an individual and his ideas over time](https://egrove.olemiss.edu/aah_journal/vol40/iss1/5/). Dale Flesher and Gary Previts, Accounting Historians Journal, 2013. The scholarly history, with Brown's own account of the 1914 report. Long. - [DuPont analysis](https://en.wikipedia.org/wiki/DuPont_analysis). Wikipedia's summary of the three-step and five-step forms, with notes on industries where the terms are less meaningful. ## Related frameworks - [Economic Value Added](https://usefulconsultingframeworks.com/frameworks/eva/): Adds a charge for the cost of capital, which DuPont leaves out. Pick it when the question is whether returns exceed what the capital costs. - [Altman Z-Score](https://usefulconsultingframeworks.com/frameworks/altman-z-score/): Also works from the published ratios, but screens for survival rather than explaining return. Pick it when the question is whether the company is in trouble. - [Activity-Based Costing](https://usefulconsultingframeworks.com/frameworks/activity-based-costing/): If the margin term is where the gap sits, it shows which products or customers carry the margin. DuPont stays at the company level. Last updated October 19, 2026.