DuPont analysis
/ doo-PONT /
When a single number disappoints, the useful question is 'why?'. If your monthly savings fell, was it because you earned less, spent a bigger share, or borrowed more? DuPont analysis applies exactly this detective approach to return on equity (ROE): instead of accepting one headline figure, it breaks ROE into the separate forces that drive it, so you can see which one is helping and which is hurting.
Developed at the DuPont company in the early 1900s, the framework splits ROE into three multiplied parts: net margin (net income / sales), asset turnover (sales / total assets), and the equity multiplier (total assets / equity). Multiply them and the sales and assets cancel out, returning ROE = net income / equity. Each part has a plain meaning: net margin is how profitable each sale is, asset turnover is how hard the assets work, and the equity multiplier is how much leverage is used. So an ROE of, say, 18% might come from 6% margin times 1.5 turnover times 2.0 leverage — telling a very different story than 9% margin times 2.0 turnover times 1.0 leverage, even though both land at 18%.
DuPont analysis matters because two firms with identical ROE can be utterly different underneath — one excellent at operations, the other simply piling on debt. It guides managers to the exact lever to pull and warns investors when a flattering ROE is really borrowed risk in disguise. The caveat: DuPont only decomposes the accounting figures it is given. It cannot fix bad inputs, and the equity multiplier rewards leverage on paper without flagging the danger that the same leverage brings, so a 'strong' DuPont breakdown can still describe a fragile company.
Two firms both report 18% ROE. DuPont reveals firm A's comes from a strong 9% net margin and brisk turnover with little debt, while firm B's comes from a thin 4% margin propped up by heavy leverage — same ROE, opposite risk.
The same ROE, taken apart, reveals one strong firm and one fragile one.
DuPont's equity multiplier makes leverage look like a virtue because it raises ROE on paper, but it does not warn that the same leverage raises the risk of ruin.