In around two minutes you will know what is the DuPont Analysis. You will get both professional definition and easy explanation. No intro, no outro, straight to the point.
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DuPont Analysis is the method of estimating the financial performance of a company. The DuPont analysis is an alternative method of calculating a company’s Return on equity. And if you are not sure what Return on Equity means, feel free to watch one of my previous videos.
There are several methods of estimating the efficiency of a company. And of such methods is called the DuPont Analysis. Which is basically an advance way of calculating the Return on Equity.
Basic ROE calculation is good in most cases, but sometimes can be distorted if a company is heavily leveraged. That is why the DuPont analysis takes this into consideration and provides us with more accurate results.
The formula of ROE calculation using the DuPont Analysis is the following. ROE equals net profit margin multiplied by asset turnover multiplied by equity multiplier.
Net profit margin in return is the net income divided by total revenue. Both components of this formula can be found on the income statement.
Asset turnover is the total sales, which in most cases is the same as total revenue, divided by average total assets. Sales or revenue can be found on the income statement and total assets are located on the balance sheet.
And equity multiplier is average total assets divided by average shareholders’ equity. Both components of this formula are located on the balance sheet.
Net profit margin measures operating efficiency. In another words, how effective is the management of the company at cutting costs and saving money.
Asset turnover measures the efficiency of a company's management at using its own assets to generate revenue.
And equity multiplier measures the level of financial leverage that a company has. The higher this number is, the more leveraged the company is. Meaning that it has more borrowed capital that its own capital, which is usually not good.
As you can see from the formula, the DuPont analysis has three parts. And if a company’s ROE increased due to an increase in the first two components, net profit margin or asset turnover, then this is a good sign.
It means that a company became more efficient at operating its business and utilizing its assets comparing to the previous period.
But if ROE increased due to an increase in equity multiplier, then it is a sign that a company became more leveraged. Which is, like mentioned previously, is not ideal in most cases.
So, if you see that a company’s ROE increased from the last reporting period, make sure to use the DuPont analysis and track what caused such increase and whether it was a healthy increase.
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*None of this is meant to be construed as investment advice, it's for entertainment purposes only. Links above include affiliate commission or referrals. I'm part of an affiliate network and I receive compensation from partnering websites. The video is accurate as of the posting date but may not be accurate in the future.
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