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DuPont analysis interpretation
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Which insights can we gain from doing a DuPont analysis? • If you want to successfully apply DuPont analysis, you need to know how to calculate its components, decide what to compare to, and most importantly apply a structured approach to interpreting the numbers. • Let’s use a real world example: industrial gas company Linde. • ⏱️TIMESTAMPS⏱️ • 00:00 DuPont analysis • 00:21 Return on Equity formula • 00:57 DuPont formula • 01:55 How to compare Return On Equity • 03:24 Analyzing Return On Sales • 08:29 ROS analysis summary • 09:02 Analyzing Asset Turnover • 10:26 Analyzing Leverage • The Return On Equity formula puts net income in the numerator, and equity in the denominator. If we pull up the latest income statement, we find net income near the bottom of the page: $6.3B in the year 2023. If we pull up the balance sheet, we find the opening balance and the ending balance of equity for the year. The average of those two numbers if $41.2B. Divide $6.3B in net income by $41.2B in average equity, and you get an ROE of 15.4%. • Now let’s split that ROE into three parts: • net income over sales, or return on sales • sales over assets, or asset turnover, and • assets over equity, or leverage. • We have already found net income and average equity, so let’s put these into place. Sales, just like net income, can be found in the income statement. Assets are on the left-hand side of the balance sheet. Assets, just like equity, have an opening balance and an ending balance, the average of these two numbers is $80.2B. That completes the input into the DuPont formula. Let’s see what the results are: return on sales of 19.3%, asset turnover of 0.41, and leverage of 1.95. Multiplying these three components of the DuPont formula gets you to the same ROE of 15.4% that we saw earlier. • So is that good or bad? How do these numbers compare? How do we interpret this DuPont analysis? You have two choices here: either compare the ratios to the historical performance of the same company, or to the same year performance of a competitor. In this video, we take the first route: we will compare Return On Equity (and its components) over the years. • We already calculated 2023, and will leave those numbers in place. • For 2022, using the data in the income statement and the balance sheet of that year, we get an ROS of 12.8%, an asset turnover of 0.41 and leverage of 1.86. In total, Return On Equity of 9.9%. • 2021: ROS of 12.9%, asset turnover 0.36, leverage 1.79, ROE 8.3%. • 2020: ROS of 9.6%, asset turnover 0.31, leverage 1.73, ROE 5.2%. • Over those four years in our sample, ROE has gone up significantly, from 5.2% in 2020 to 15.4% in 2023. ROE nearly tripled! What was the main factor that contributed to that increase? • Return On Sales doubled, while asset turnover and leverage also moved up, but much more modestly. So on our quest to find the story behind these numbers, let’s focus on the big impact factor first: how did Return On Sales develop over the years? • If ROS goes up, then most likely, Net Income has grown faster than Sales. This is where we pull in another financial analysis tool to dig deeper and help us gather insights: hello DuPont analysis, meet horizontal analysis! Horizontal analysis is used to evaluate a company's performance over time: spotting the direction of change in account balances, and the magnitude in which that change has occurred. • What our horizontal analysis shows us here is that four major expense lines have either decreased over time, or have grown at a slower pace than sales, causing Net Income to grow very impressively. • Our #DuPontanalysis hinted to us that Net Income has grown faster than Sales. Our horizontal analysis quantified that Net Income has grown 141% while Sales grew 21%, and provided us with the operational drivers, the narrative, the story behind the numbers: higher pricing, productivity improvements, and decrease in purchase accounting impacts as well as “unusual items”. • Philip de Vroe (The Finance Storyteller) aims to make accounting, finance and investing enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: YouTube videos, livestreams, classroom sessions, and webinars. Connect with me through Linked In! • Want to get access to bonus content, and/or express your gratitude by buying me a cup of tea? Join my channel as a member through / @thefinancestoryteller
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