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.

 

Find

 

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

 

Step 2

 

Find

 

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

 

Step 3

 

Find

 

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

 

Step 4

 

Find

 

Return on equity =   Net income/Common equity

 

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

 

References

 

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

http://knol.google.com/k/narayana-rao-kvss/fundamental-analysis-grahamrao-method/2utb2lsm2k7a/7

 

 

Estimating Aggregate Operating Profit Margin for the Next Year

http://knol.google.com/k/narayana-rao-kvss/-/2utb2lsm2k7a/139

 

 

 

Security Analysis Article Directory

 

 

 

 

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Original knol - http://knol.google.com/k/narayana-rao/dupont-analysis/2utb2lsm2k7a/ 142

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