Sunday, April 22, 2012

Dupont Analysis

The breakdown of return on equity into several components is now referred to as DuPont system.



The return on equity is a useful ratio as the growth rate expected for the future periods is estimated by the relation


Expected growth rate = Expected Return on Equity * Expected Retention ratio


To develop expectation return on equity is broken down into components and expectations are formed at component level.



Three-Component Breakdown System



Return on equity = Net income/Common equity


= Net profit margin * Total asset turnover * Financial leverage


Net profit margin   = Net income/Net sales


Total asset turnover = Net sales/Total assets


Financial leverage = Total assets/Common equity




Five-Component Breakdown System



Step 1.




EBIT/Total assets = [EBIT/Net sales]*[Net sales/Total assets]


Step 2




Net profit before tax (NBT)/Total assets = [EBIT/Total assets] – [Interest expense/Total assets]


Step 3




Net profit before tax (NBT)/Common equity = [Net profit before tax (NBT)/Total assets]*[Total assets/Common equity]


Step 4




Return on equity =   Net income/Common equity


= [Net profit before tax (NBT)/Common equity]*[100% - Income taxes/Net before taxes]




Reilly, Frank F., and Keith C. Brown (2006), Investment Analysis and Portfolio Management, 8th Edition, Thomson South Western, (Main text for the series of revision articles on Security Analysis)


Related Articles


Fundamental Analysis – Graham–Rao Method



Estimating Aggregate Operating Profit Margin for the Next Year




Security Analysis Article Directory





Original knol - 142

No comments:

Post a Comment