DuPont Decomposition
Three-factor decomposition of ROE: net margin × asset turnover × equity multiplier. Identifies the source of a company's ROE — operating profitability, asset efficiency, or financial leverage.
When to use: Use to diagnose ROE quality. A 20% ROE driven by operating efficiency is more durable than a 20% ROE driven by 5× leverage. Year-over-year DuPont decomposition shows what is changing inside the ROE number.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| ROE | Return on Equity | Net income divided by shareholders' equity | % |
| NetMargin | Net Profit Margin | Net income divided by revenue | % |
| AssetTurnover | Asset Turnover | Revenue ÷ total assets | integer |
| EquityMultiplier | Equity Multiplier | Total assets ÷ shareholders' equity (financial leverage) | integer |
Real-Life Examples
Example 1: Decomposed ROE
Company has 10% net margin, 1.0× asset turnover, 2.0× equity multiplier.
Given
Step-by-Step
20% ROE — but the breakdown matters. Half the return comes from financial leverage (the 2.0× equity multiplier). A peer with 15% margins, 1.5× turnover, and 1.0× multiplier (no leverage) would deliver a 22.5% ROE that is structurally higher quality.
Frequently Asked Questions
Net margin = operating efficiency (profit per dollar of sales). Asset turnover = capital efficiency (sales per dollar of assets). Equity multiplier = financial leverage (assets per dollar of equity). Together they produce ROE.
Five-step DuPont breaks net margin into: (Tax burden) × (Interest burden) × (EBIT margin), then adds asset turnover and equity multiplier. Useful for isolating tax and financing effects from pure operating performance.
For capital-light businesses with stable cash flows (banks, utilities, REITs) — leverage is a feature, not a bug. For cyclicals or businesses with volatile margins, high leverage amplifies downside risk and can turn a 20% ROE into a near-bankruptcy in a downturn.