ROE

DuPont method is a method for assessing a company’s return on equity. The name comes from the DuPont Corporation that started using this analysis in the 1920s. The formula is also known as the ROE.

ROE= (Net profit/Revenue)*(Revenue/Total assets)*(Total assets/Equity)=Net profit margin*Asset turnover*Financial leverage

ROE tells about three things:

Operating efficiency
Asset use efficiency
Financial leverage

Operating efficiency reflects management pricing and cost strategy. Management must price a product to be as profitable as possible while still generating stable sales growth.

Asset turnover means that management must increase sales while holding investment in assets relative constant and paying attention to:

obsolete and redundant assets
collection of receivables
credit terms and policies
unused fixed assets

Financial leverage means that the company is relying more on debt to finance its assets. A company can boost its return on equity by raising its equity multiplier, increasing the amount of debt.

The known problems of ROE are:

timing problem: new products are not so profitable
risk problem: financial leverage can cause too much debt
value problem: ROE rely on book value