Du Pont Identity

Du Pont Identity

An expression breaking down return on equity (ROE) into three parts: profit margin, total asset turnover, and financial leverage.

The Du Pont identity tells us that ROE is affected by 3 things:
-Operating efficiency (as measured by profit margin)
-Asset use efficiency (as measured by total asset turnover)
-Financial leverage (as measured by the equity multiplier)

Notes:

If ROE is unsatisfactory, the Du Pont identity helps locate which part of the business is underperforming.

Here is how the DuPont identity is derived:

ROE = Return on Equity
NI = Net Income
TE = Total Equity
TA = Assets
ROA = Return on Assets
EM = The equity Multiplier
S = Sales

ROE = NI / TE
Multiply by 1 (TA/TA) and then rearrange
ROE = (NI / TE) (TA / TA)
ROE = (NI / TA) (TA / TE) = ROA * EM
Multiply by 1(S/S) and then rearrange
ROE = (NI / TA) (TA / TE) (S/S)
ROE = (NI / S) (S / TA) (TA / TE)
ROE = PM * TAT * EM
ROE = Profit margin * Total asset turnover * Equity multiplier

See also: Asset, Asset Turnover, Equity Multiplier, Leverage, Profit Margin, Return on Assets (ROA), Return on Equity (ROE)