DuPont decomposition

ROE is the most important single metric for an equity investor, it tells you how much the company earned on shareholders' capital. But a high ROE can arise for very different reasons: superior margins, better asset utilisation, or simply higher financial leverage. DuPont decomposition breaks ROE into these components to reveal which driver is responsible.

Invented by DuPont Corporation in the 1920s, this decomposition is as relevant today as it was a century ago. A company with 25% ROE driven by 20% PAT margins and moderate leverage is a very different investment than one with 25% ROE driven by razor-thin margins, massive asset turnover, and 8× leverage.

Decomposing ROE across time (has the driver mix changed?) and across peers (why does Company A have higher ROE than Company B?) provides the most structured framework for comparing businesses.

Three-factor DuPont:

ROE = Net Profit Margin × Asset Turnover × Financial Leverage

ROE = (PAT/Revenue) × (Revenue/Assets) × (Assets/Equity)

Example: PAT Margin = 10%, Asset Turnover = 1.5×, Leverage = 2.0× → ROE = 10% × 1.5 × 2.0 = 30%

Five-factor DuPont (extended):

ROE = Tax Burden × Interest Burden × EBIT Margin × Asset Turnover × Leverage

ROE = (PAT/PBT) × (PBT/EBIT) × (EBIT/Revenue) × (Revenue/Assets) × (Assets/Equity)

• Tax Burden = PAT/PBT (1 − effective tax rate)
• Interest Burden = PBT/EBIT (reflects cost of debt)
• EBIT Margin = pure operating profitability
• Asset Turnover = efficiency
• Leverage = equity multiplier

This five-factor version separates the effect of tax management and interest costs from operating profitability, useful when comparing companies across tax jurisdictions or with different financing.