Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “DuPont Analysis”.
The DuPont analysis also called the DuPont model is a financial ratio based on the return on equity ratio that is used to analyze a company's ability to increase its return on equity. In other words, this model breaks down the return on equity ratio to explain how companies can increase their return for investors.
In the 1920s the DuPont Corporation created an analysis method that fills this need by breaking down ROE into a more complex equation. DuPont analysis shows the causes of shifts in the number. The name has stuck with it ever since. Return on equity known as ROE is a closely watched number among knowledgeable investors. It is a strong measure of how well a company's management creates value for its shareholders. The number can be misleading, however, as it is vulnerable to measures that increase its value while also making the stock more risky. Without a way of breaking down ROE components, investors could be duped into believing a company is a good investment when it's not.
The DuPont analysis looks at three main components of the ROE ratio.
Profit Margin
Total Asset Turnover
Financial Leverage
Based on these three performances measures the model concludes that a company can raise its Return on Investment by maintaining a high profit margin, increasing asset turnover, or leveraging assets more effectively.
By Barry Norman, Investors Trading Academy
What is DuPont Analysis?
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