The DuPont formula segments ROE and helps us make more sense of it
11-Feb-2019 •Jugal Harpalani
ROE (return on equity) is one of the most important and common ratios used to analyse a company. And why not? We all want to see how much of the income is attributable to shareholders, who own the equity. However, just dividing net income by shareholders' equity can only tell you so much. In the 1920s, the DuPont Corporation developed a formula which broke ROE into three components: profit margin, asset turnover and financial leverage. This helps us understand the reason behind the increase or decrease in ROE. Here is the DuPont equation:
ROE = (Net income/Sales) x (Sales/Total assets) x (Total assets/Total equity)
The first part of the formula calculates profit margin. Profit margins usually increase if there is any increase in the selling price and/or decrease in expenses. An increase in the profit margin reflects a strong bargaining power. Asset turnover (the second part of the formula) tells us how efficiently a company is able to use its assets to generate revenue. A high asset turnover is usually the result of a company successfully increasing its sales and managing its assets in an optimal manner.
These two components examine the operations of a business. It is usually preferable that ROE increases due to any one or both of these factors (in case of the highlighted names, it increases because of both). However, it is worth noting here that net profit margin and asset turnover can be in contrast. For example, a company in the fast-food business may have a high asset turnover due to relatively lower assets but lower profit margins. Similarly, a manufacturer of customised and expensive equipment may have a low asset turnover but high profit margins.
The third part of the equation is financial leverage, which is also known as the equity multiplier. It tells us how much debt a company uses to fund its assets. Let's say a company has Rs 100 as assets and Rs 20 as owners' equity. The balance-sheet equation (assets less liability equals to equity) will signify Rs 80 as company debt. Hence, if a company borrows more to finance its assets, the ratio has to increase. This increases a company's risk of default and makes it riskier. However, the equity multiplier may increase due to reasons apart from an increase in debt.
We applied DuPont equation on the companies which have an ROE of more than 20 per cent. The tables list the results as per each segment.
| Company name | Profit margin (%) | |||
| 2018 | 2017 | 2016 | 2015 | |
| Eris Lifesciences Ltd | 34.48 | 32.9 | 22.37 | 16.29 |
| Indiabulls Real Estate Ltd | 33.49 | 15.28 | 10.9 | 10.28 |
| Muthoot Finance Ltd | 27.22 | 20.42 | 16.62 | 15.53 |
| Caplin Point Laboratories Ltd | 26.79 | 23.78 | 19.17 | 16.33 |
| MAS Financial Services Ltd | 23.36 | 19.06 | 18.22 | 17.33 |
| Strides Pharma Science Ltd | 20.88 | 11.65 | 3.48 | 0.08 |
| Eicher Motors Ltd | 20.86 | 19.19 | 17.07 | 7.5 |
| Bajaj Finance Ltd | 19.89 | 18.43 | 17.53 | 16.68 |
| Navin Fluorine International Ltd | 19.72 | 17.49 | 11.57 | 9.25 |
| Can Fin Homes Ltd | 19.55 | 17.39 | 14.51 | 10.57 |
| Mahanagar Gas Ltd | 19.48 | 17.57 | 13.6 | 13.13 |
| IIFL Holdings Ltd | 18.51 | 17.07 | 14.04 | 13.41 |
| Tata Chemicals Ltd | 18.38 | 7.97 | 5.66 | 4.6 |
| Cholamandalam Investment & Finance Company Ltd | 17.7 | 15.3 | 13.64 | 11.96 |
| Dabur India Ltd | 17.52 | 16.62 | 15.94 | 13.51 |
| Mayur Uniquoters Ltd | 16.67 | 15.67 | 14.12 | 11.82 |
| Castrol India Ltd* | 16.57 | 16.09 | 15.36 | 11.63 |
| GIC Housing Finance Ltd | 16.37 | 14.77 | 14.24 | 14.09 |
| Pidilite Industries Ltd | 15.46 | 14.15 | 14.1 | 9.91 |
| Maithan Alloys Ltd | 15.43 | 12.79 | 6.52 | 4.54 |
| Avanti Feeds Ltd | 13.72 | 8.66 | 7.88 | 6.55 |
| Elantas Beck India Ltd* | 13.63 | 13.3 | 10.8 | 8.26 |
| Orient Refractories Ltd | 13.5 | 12.39 | 11.29 | 10.86 |
| TTK Prestige Ltd | 13.25 | 8.04 | 7.42 | 6.49 |
| Akzo Nobel India Ltd | 13.15 | 7.88 | 7.3 | 6.66 |
| Balaji Amines Ltd | 12.91 | 11.27 | 8.25 | 4.93 |
| BLS International Services Ltd | 12.23 | 7.89 | 6.12 | 5.24 |
| Bharat Rasayan Ltd | 12.13 | 8.07 | 6.93 | 6.67 |
| 3M India Ltd | 12.03 | 9.8 | 8.76 | 5.62 |
| Solar Industries (India) Ltd | 11.97 | 11.38 | 11.28 | 10.69 |
| Garware Technical Fibres Ltd | 11.88 | 9.93 | 7.47 | 5.48 |
| Gulf Oil Lubricants India Ltd | 11.5 | 9.33 | 8.58 | 6.94 |
| Hero MotoCorp Ltd | 11.09 | 10.42 | 10.02 | 8.03 |
| Bodal Chemicals Ltd | 10.68 | 9.93 | 8.7 | 8.13 |
| Sterling Tools Ltd | 10.5 | 9.45 | 6.74 | 5.61 |
| Asian Paints Ltd | 10.27 | 10.18 | 9.91 | 8.63 |
| DCM Shriram Ltd | 9.54 | 9.03 | 4.98 | 3.58 |
| Suprajit Engineering Ltd | 9.52 | 8.78 | 7.76 | 7.53 |
| Tasty Bite Eatables Ltd | 8.93 | 8.67 | 7.69 | 6.06 |
| VIP Industries Ltd | 8.74 | 6.52 | 5.38 | 4.38 |
| Bhansali Engineering Polymers Ltd | 8.27 | 5.06 | 2.72 | 0.73 |
| Relaxo Footwears Ltd | 8.2 | 7.26 | 6.94 | 6.87 |
| VenkyS (India) Ltd | 7.43 | 5.04 | 1.8 | 1.08 |
| Dilip Buildcon Ltd | 7.18 | 6.72 | 5.34 | 2.94 |
| Lux Industries Ltd | 6.96 | 6.23 | 5.46 | 4.98 |
| Rain Industries Ltd* | 6.91 | 3.12 | 2.89 | 0.57 |
| Minda Industries Ltd | 6.77 | 4.51 | 4.09 | 2.5 |
| Sheela Foam Ltd | 6.67 | 6.63 | 6.17 | 2.75 |
| HG Infra Engineering Ltd | 6.05 | 5.06 | 4.07 | 2.53 |
| Endurance Technologies Ltd | 5.86 | 5.51 | 5.35 | 4.84 |
| Automotive Axles Ltd | 5.4 | 3.8 | 2.88 | 2.07 |
| BASF India Ltd | 4.31 | -0.26 | -0.59 | -1.31 |
| KEI Industries Ltd | 4.13 | 3.31 | 2.48 | 1.59 |
| Jindal Stainless (Hisar) Ltd | 4.13 | 2.79 | 0.47 | -0.07 |
| TVS Motor Company Ltd | 3.99 | 3.75 | 3.41 | 2.9 |
| * Financial year ending Dec 2017 | ||||
| Company name | Asset turnover (times) | |||
| 2018 | 2017 | 2016 | 2015 | |
| Mishtann Foods Ltd | 7.36 | 5.07 | 3.63 | 0.2 |
| Hindustan Petroleum Corporation Ltd | 2.9 | 2.89 | 2.55 | 2.52 |
| Vakrangee Ltd | 2.48 | 1.84 | 1.55 | 1.48 |
| Automotive Axles Ltd | 2.4 | 2.32 | 2.19 | 0.91 |
| VenkyS (India) Ltd | 1.93 | 1.73 | 1.45 | 1.31 |
| Maithan Alloys Ltd | 1.79 | 1.65 | 1.53 | 1.48 |
| Hexaware Technologies Ltd | 1.71 | 1.69 | 1.67 | 1.46 |
| West Coast Paper Mills Ltd | 1.59 | 1.14 | 0.99 | 0.87 |
| BASF India Ltd | 1.48 | 1.44 | 1.2 | 1.07 |
| Ahluwalia Contracts (India) Ltd | 1.35 | 1.21 | 1.15 | 1.02 |
| Balaji Amines Ltd | 1.19 | 1.15 | 1.14 | 1.08 |
| CRISIL Ltd* | 1.17 | 1.16 | 1.09 | 1.06 |
| Meghmani Organics Ltd | 1.09 | 0.97 | 0.93 | 0.88 |
| KNR Construction Ltd | 0.87 | 0.8 | 0.6 | 0.54 |
| Dilip Buildcon Ltd | 0.83 | 0.74 | 0.72 | 0.6 |
| Thyrocare Technologies Ltd | 0.79 | 0.72 | 0.66 | 0.56 |
| Oracle Financial Services Software Ltd | 0.77 | 0.77 | 0.5 | 0.35 |
| Reliance Nippon Life Asset Management Ltd | 0.69 | 0.66 | 0.65 | 0.47 |
| Bharat Dynamics Ltd | 0.63 | 0.55 | 0.45 | 0.34 |
| Adani Transmission Ltd | 0.25 | 0.23 | 0.19 | 0.02 |
| Muthoot Finance Ltd | 0.2 | 0.2 | 0.18 | 0.16 |
| * Financial year ending Dec 2017 | ||||
| Company name | Assets to equity (times) | |||
| 2018 | 2017 | 2016 | 2015 | |
| Coal India Ltd | 5.35 | 3.81 | 2.92 | 2.55 |
| Bajaj Consumer Care Ltd | 1.21 | 1.19 | 1.17 | 1.14 |
