DuPont analysis: splitting ROE into three drivers
The same ROE (return on equity) can come from a high margin, from turning assets quickly, or from borrowing more. DuPont analysis breaks ROE into the product of three drivers so you can see what is actually producing the return.
Formula
ROE = net margin × asset turnover × equity multiplier
- Net margin = net income ÷ revenue: how much is kept from each sale (profitability)
- Asset turnover = revenue ÷ total assets: how much is sold per unit of assets (efficiency)
- Equity multiplier = total assets ÷ equity: how many assets are run per unit of owners' money (leverage)
Multiplying the three gives net income ÷ equity, which is ROE. Caveat uses period-end balances.
Worked example
The table shows the current and prior year of the fictional company used throughout these guides (revenue KRW 30 hundred million, net income 2.4, total assets 18, equity 9, all in hundred-million KRW). The figures come from Caveat's calculation engine.
| Driver | Prior | Current |
|---|---|---|
| Net margin | 5.9% | 8% |
| Asset turnover | 1.69× | 1.67× |
| Equity multiplier | 2.05× | 2× |
| ROE | 20.5% | 26.7% |
ROE rose from 20.5% to 26.7%, and the cause is a higher net margin. Turnover and the equity multiplier actually eased slightly.
How to read it
What counts as a good ROE differs by industry, but the breakdown does show why ROE changed.
- Margin-driven: pricing, cost or overhead structure may have improved. Check that one-off gains are not mixed in.
- Turnover-driven: more sales from the same assets, or idle assets were reduced.
- Multiplier-driven: more borrowing spreads the same profit over a smaller equity base. In a downturn the effect works in reverse.
Caveat reports classify the change in ROE this way: negative ROE is at risk; if only the equity multiplier rose while margin and turnover did not, leverage-driven; otherwise operations-driven. This example is operations-driven.
Both sides: leverage is not bad in itself; if the business earns more than the interest it pays, borrowing legitimately lifts ROE. Conversely, a higher margin is not always skill: it can come from asset-sale gains or temporary cost cuts. Industries also differ: retail runs thin margins with fast turnover, capital-intensive industries the opposite.
Limitations
- Period-end balances differ from averages for companies whose balances moved a lot during the year.
- When equity is near zero or negative, the equity multiplier and ROE cannot be interpreted.
- For individual proprietors, pre-tax profit stands in for net income.
- This is the three-step form, so tax and interest burdens sit inside the net margin.
- This is reference analysis and does not replace credit, investment or tax decisions.
See it in your own statements
Upload a balance sheet and income statement and Caveat calculates these for your company.
FAQ
- Is a higher ROE always better?
- Benchmarks differ by industry, so the level alone tells little. The same ROE is more or less sustainable depending on whether it comes from margin or leverage, which is why you split it.
- What is the difference between the three-step and five-step DuPont analysis?
- The five-step form splits the net margin further into a tax burden (net income ÷ pre-tax profit), an interest burden (pre-tax profit ÷ operating profit) and the operating margin. Caveat uses the three-step form.
- Why is a high equity multiplier risky?
- A high multiplier means little equity relative to assets, so when profit falls, losses eat into equity quickly. Industries with stable cash flow can nonetheless carry a high multiplier.
- Which financial statement items are needed?
- Four: revenue, net income, total assets and equity.
Country notes: Korea
- How are Korean sole-proprietor statements handled?
- The sole-proprietor standard statement has no after-tax net income, so pre-tax income is used instead. Net margin and ROE therefore come out higher than for a corporation.