The 3-step DuPont formula
ROE = net margin × asset turnover × equity multiplier
- Net margin = net income ÷ revenue. How much of each dollar of sales is profit.
- Asset turnover = revenue ÷ average total assets. How many dollars of sales each dollar of assets generates.
- Equity multiplier = average total assets ÷ average equity. How much of the assets is financed by debt rather than by shareholders.
Multiply the three and revenue and assets cancel out: what is left is net income ÷ equity, which is ROE. That is why the DuPont result must match the plain ROE exactly. If it does not, a reference is wrong, or you used year-end figures in one place and averages in another.
Worked example: DuPont analysis in Excel
Six inputs per company. Every ratio is a formula, and row 12 checks the DuPont result against the plain ROE.
| A | B | C | Formula in B | |
|---|---|---|---|---|
| 1 | $m | Premium brand | Discount retailer | |
| 2 | Revenue | 500 | 2,000 | |
| 3 | EBIT (operating profit) | 90 | 76 | |
| 4 | Earnings before tax | 80 | 60 | |
| 5 | Net income | 60 | 45 | |
| 6 | Average total assets | 400 | 900 | |
| 7 | Average equity | 300 | 225 | |
| 8 | Net margin | 12.00% | 2.25% | =B5/B2 |
| 9 | Asset turnover | 1.25 | 2.22 | =B2/B6 |
| 10 | Equity multiplier | 1.33 | 4.00 | =B6/B7 |
| 11 | ROE (3-step DuPont) | 20.0% | 20.0% | =B8*B9*B10 |
| 12 | Check: net income ÷ average equity | 20.0% | 20.0% | =B5/B7 |
| 13 | Tax burden (NI ÷ EBT) | 0.750 | 0.750 | =B5/B4 |
| 14 | Interest burden (EBT ÷ EBIT) | 0.889 | 0.789 | =B4/B3 |
| 15 | EBIT margin | 18.0% | 3.8% | =B3/B2 |
| 16 | ROE (5-step DuPont) | 20.0% | 20.0% | =B13*B14*B15*B9*B10 |
Two companies, one ROE, three different stories
The premium brand earns a net margin of 12% but turns its assets over only 1.25 times a year, and it uses little debt (equity multiplier 1.33). Its return comes from pricing power.
The discount retailer keeps only 2.25% of each sale as profit. It makes up for that with an asset turnover of 2.22, selling far more per dollar of stores and stock, and with heavy leverage: an equity multiplier of 4.00 means that three quarters of its assets are financed by liabilities.
Both arrive at 20%. But the retailer's ROE depends on leverage, so a small drop in margin hurts its shareholders much more. Its return on assets (margin × turnover) is only 5%, against the brand's 15%. The DuPont split makes that risk visible, while ROE alone hides it.
The 5-step DuPont formula
The extended version splits net margin further, to separate operations from financing and tax:
ROE = tax burden × interest burden × EBIT margin × asset turnover × equity multiplier
- Tax burden = net income ÷ earnings before tax: the share of pre-tax profit that is left after tax.
- Interest burden = earnings before tax ÷ EBIT: the share of operating profit that is left after interest.
- EBIT margin = EBIT ÷ revenue: operating profitability.
Both companies pay the same 25% tax rate, so the tax burden is 0.75 for each. The interest burden shows the cost of the retailer's debt: interest takes 21% of its operating profit, against 11% for the brand. The five factors multiply to the same 20%.
How to use DuPont analysis
DuPont is most useful over time and against peers. If a company's ROE rises, check which factor moved. Higher margins or faster turnover are operating improvements. A higher equity multiplier means more debt: the return went up, but so did the risk. A buyback financed with debt raises ROE without making the business any better.
Use average assets and equity, (opening + closing) ÷ 2, because net income is earned over the whole year while the balance sheet is a snapshot. Whichever you choose, use it for every factor.
Setting it up in Excel
Put the six inputs for each company in a column: revenue, EBIT, earnings before tax, net income, average total assets and average equity. Each factor is then a two-cell formula, such as =B5/B2 for net margin, and ROE is the product =B8*B9*B10. Add a check row with =B5/B7 directly below: if the two ROE figures ever differ, a reference is wrong. Format margins and ROE as percentages, and turnover and the multiplier as plain numbers with two decimals.
Limits of DuPont analysis
DuPont analysis explains ROE, it does not judge it. It relies on accounting figures, so one-off gains, write-downs or unusual tax items can distort a single year. It also says nothing about cash flow or about whether the leverage is sustainable. Read it as a map that tells you which part of the business to look at next, not as a verdict.
Common mistakes
- Mixing year-end and average balances. The DuPont product then no longer equals net income ÷ equity.
- Reading a high ROE as good management. Check the equity multiplier first. Debt can produce a high ROE from a weak business.
- Using total liabilities and equity inconsistently. The equity multiplier is total assets ÷ equity, which is the same as 1 + total liabilities ÷ equity.
- Comparing across industries. Retailers, banks and software firms have structurally different margins, turnover and leverage.
- Ignoring negative equity. If equity is negative, ROE and the equity multiplier lose their meaning. Analyse margins and ROA instead.
Frequently asked questions
What are the three components of DuPont analysis?
Net profit margin (profitability), asset turnover (efficiency) and the equity multiplier (financial leverage). Multiplied together they equal return on equity.
What is the difference between 3-step and 5-step DuPont?
The 5-step version splits net margin into tax burden, interest burden and EBIT margin, so you can separate operating performance from the effects of interest and tax.
Why use average assets and average equity?
Net income is earned over the year, while balance sheet figures are a snapshot at one date. Averages match the two better, especially when the balance sheet changed a lot during the year.
How does DuPont relate to ROA?
Net margin × asset turnover is return on assets. ROE is ROA multiplied by the equity multiplier, so the gap between ROA and ROE shows how much leverage adds.