Final answer:
The DuPont Decomposition of ROE is a financial analysis technique used to break down a company's Return on Equity (ROE) and understand its drivers. It is typically done in three stages: decomposing ROE into Profit Margin and Asset Turnover, breaking down Profit Margin into Operating Margin and Financial Leverage, and decomposing Asset Turnover into Sales-to-Assets Ratio and Asset Turnover. By analyzing each stage, we can gain insights into a company's profitability and efficiency.
Step-by-step explanation:
What is DuPont Decomposition of ROE?
The DuPont Decomposition of ROE, also known as the DuPont Analysis, is a financial analysis technique used to break down the components of a company's Return on Equity (ROE) and understand its drivers. It helps identify the sources of a company's profitability and measure the efficiency and effectiveness of its operations.
Stages of DuPont Decomposition of ROE
The DuPont Decomposition of ROE is typically done in three stages:
Stage 1: Decomposition of ROE into Profit Margin and Asset Turnover
Stage 2: Decomposition of Profit Margin into Operating Margin and Financial Leverage
Stage 3: Decomposition of Asset Turnover into Sales-to-Assets Ratio and Asset Turnover
Example
Let's say a company has an ROE of 15%. Using the DuPont Decomposition, we can determine the factors contributing to this ROE. In Stage 1, we analyze the Profit Margin and Asset Turnover. If the Profit Margin is 8% and the Asset Turnover is 1.2, we can calculate the ROE as 8% * 1.2 = 9.6%. In Stage 2, we further break down the Profit Margin into Operating Margin and Financial Leverage. Finally, in Stage 3, we decompose the Asset Turnover into Sales-to-Assets Ratio and Asset Turnover. By analyzing each stage, we can gain a comprehensive understanding of the company's ROE.