RETURN ON EQUITY CHEAT SHEET

Return on Equity (ROE) is a fundamental performance measure to analyze the return for owners or investors.

The DuPont Formula breaks down ROE into its individual components, providing context on business efficiency and financing.

This formula originated at the DuPont Chemical Company in the 1900s.

𝗗𝗨𝗣𝗢𝗡𝗧 𝗙𝗢𝗥𝗠𝗨𝗟𝗔 𝗘𝗫𝗣𝗟𝗔𝗜𝗡𝗘𝗗

- 𝗥𝗲𝘁𝘂𝗿𝗻 𝗼𝗻 𝗘𝗾𝘂𝗶𝘁𝘆 is Net Profit divided by Equity. However, this alone lacks context. For a meaningful analysis, it's crucial to understand the underlying drivers.

- 𝗛𝗼𝘄 𝗶𝘁 𝘄𝗼𝗿𝗸𝘀: Both Net Profit and the Equity Balance are broken down into multiple drivers, offering detailed insights. Notably, in the formula, all components except for Net Income and Equity cancel out. For example, Operating Income appears in both the Operating Margin (top) and Interest Burden Ratio (bottom), thus canceling out. The result? Only Net Income and Total Equity remain.

𝗧𝗛𝗘 𝗧𝗛𝗥𝗘𝗘 𝗗𝗥𝗜𝗩𝗘𝗥𝗦

1. 𝗢𝗽𝗲𝗿𝗮𝘁𝗶𝗻𝗴 𝗘𝗳𝗳𝗶𝗰𝗶𝗲𝗻𝗰𝘆: Highlighted by the net profit margin (Net Income / Revenue).

2. 𝗔𝘀𝘀𝗲𝘁 𝗘𝗳𝗳𝗶𝗰𝗶𝗲𝗻𝗰𝘆: Measured by the asset turnover ratio (Revenue / Total Assets).

3. 𝗙𝗶𝗻𝗮𝗻𝗰𝗶𝗮𝗹 𝗟𝗲𝘃𝗲𝗿𝗮𝗴𝗲: Measured by the equity multiplier formula (Total Assets / Total Equity).

𝗗𝗢𝗪𝗡𝗦𝗜𝗗𝗘𝗦

- 𝗠𝗮𝗻𝗶𝗽𝘂𝗹𝗮𝘁𝗶𝗼𝗻: All accounting metrics can be manipulated or adjusted to appear better.

- 𝗡𝗼𝘁 𝗖𝗮𝘀𝗵: A higher ROE does not mean more cash is available to pay bills.

- 𝗟𝗮𝗰𝗸𝘀 𝗖𝗼𝗻𝘁𝗲𝘅𝘁: Ratios are the result, but they don't explain the "why."

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