Reviewed by Oct 05, 2020| Updated on
The DuPont methodology (also known as the DuPont identification or DuPont model) is a model popularised by the DuPont Corporation for analysing fundamental results.
DuPont analysis is a useful technique to break down the different return on equity (ROE) generators. The ROE decomposition helps investors to concentrate separately on key indicators of financial success to define strengths and weaknesses.
Three main financial metrics drive equity return (ROE): operating performance, asset usage performance, and financial leverage. Operating output is a net profit margin or a net income separated by overall revenue or profits.
The efficiency of asset usage is determined by the turnover ratio of the assets. Leverage is calculated by the equity multiplier, equal to average assets divided by average equities.
The Dupont analysis is an extended return on equity model, determined by multiplying the net profit margin with the asset turnover and the equity multiplier.
The component parts of a firm's return on equity (ROE) are calculated using a DuPont analysis. This allows an investor to assess, which financial activities contribute the most to the ROE changes.
An investor may use these analyses to compare two identical firms' operating performance. The DuPont review may be used by managers to recognise strengths or weaknesses that should be tackled.
DuPont analysis splits ROE into its constituent components to assess which of the factors are most responsible for ROE improvement.
The main disadvantage of the DuPont analysis is that it still relies on accounting equations and data that can be manipulated despite being comprehensive. However, the Dupont study, even with its comprehensiveness, lacks meaning as to why the individual ratios are high or low, or whether they should be considered high or low at all.