DuPont Analysis: Decomposing Return on Equity

Going deeper (optional). Up next: The five-factor DuPont decomposition the pros use — an advanced aside you can skip on first pass and come back to anytime. Continue when you're curious.

The three-factor model splits a company's return into profitability, efficiency, and leverage. Analysts who want to see WHY the profitability piece moved break the net-margin term into three more: ROE = Tax Burden × Interest Burden × Operating Margin × Asset Turnover × Equity Multiplier. Tax Burden (Net Income / Pretax Income) is the slice of pretax profit kept after tax; Interest Burden (Pretax Income / EBIT) is the slice of operating profit left after interest; Operating Margin (EBIT / Revenue) is core operating profitability; Asset Turnover (Revenue / Assets) is efficiency; Equity Multiplier (Assets / Equity) is leverage. This is CFA-level detail — most long-term investors can stop at the three-factor version and only reach for the five-factor split when they need to separate an operating change from a tax-rate or interest-cost change.

Illustrative example. Take a firm that keeps 0.75 of its pretax profit after tax, retains 0.80 of operating profit after interest, earns a 15% operating margin, turns its assets 0.80 times a year, and runs 2.5x leverage. The first three factors are simply the net margin in disguise: 0.75 × 0.80 × 15% = 9%. Fold in efficiency and leverage and the full chain returns ROE: 0.75 × 0.80 × 15% × 0.80 × 2.5 = 18% — the same answer as the three-factor shortcut 9% × 0.80 × 2.5 = 18%. The five-factor view never changes the number; it only tells you which lever moved. All figures illustrative.