DuPont: Breaking ROE Apart
Split ROE into margin, turnover and leverage to see what is really driving returns.
DuPont analysis cracks ROEProfit generated per rupee of shareholders’ equity. open to reveal what’s actually driving it. It splits ROEProfit generated per rupee of shareholders’ equity. into three levers, so a single number becomes a diagnosis.
ROE = Net margin × Asset turnover × Leverage
Profitability (margin) × Efficiency (sales per asset) × how much debt amplifies it.
Two companies can show the same 20% ROEProfit generated per rupee of shareholders’ equity. for opposite reasons: one via fat margins (a premium brand), another via high turnover (a thin-marginThe deposit required to hold a leveraged position. retailer spinning assets fast), a third via heavy leverageControlling a large position with a small amount of money. (risky). DuPont tells you WHICH — and a high ROEProfit generated per rupee of shareholders’ equity. built mostly on leverageControlling a large position with a small amount of money. is a very different (riskier) animal than one built on margins or efficiency.
ExampleLuxury brand: high marginThe deposit required to hold a leveraged position., low turnover, low leverageControlling a large position with a small amount of money. → quality. Supermarket: low marginThe deposit required to hold a leveraged position., high turnover, low leverageControlling a large position with a small amount of money. → efficient. Over-borrowed firm: ok margin, ok turnover, high leverage → fragile. Same ROEProfit generated per rupee of shareholders’ equity., three very different businesses.
Key takeawayDuPont decomposes ROEProfit generated per rupee of shareholders’ equity. into marginThe deposit required to hold a leveraged position. × turnover × leverageControlling a large position with a small amount of money. — revealing whether returns come from quality (marginThe deposit required to hold a leveraged position./efficiency) or risk (leverageControlling a large position with a small amount of money.).
FAQs
Why bother decomposing ROE?
Because the same ROE can be high-quality or dangerous depending on its source. DuPont shows whether a company earns its returns through pricing power, operational efficiency, or simply borrowing — which completely changes how risky and sustainable that ROE is.