For stock pickers who like digging into the weeds, traditional ratio analysis is always a great place to start.
But there are more complex methods to really get under the hood, and all you need is a company’s financial statements to get started.
Enter DuPont analysis – a powerful technique that breaks down return on equity (ROE) into three key components, revealing the true story behind a company’s financial performance.
Here’s how it works and why it matters.
This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Ratios also shouldn’t be looked at on their own.
Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.
What is return on equity?
Before diving into DuPont analysis, it’s essential to understand return on equity.
ROE measures how effectively a company uses shareholders’ equity (a stock investor's claim on the business) to generate profit.
It’s calculated as:
ROE = Net Income / Shareholders' Equity
A higher ROE suggests better financial performance, but it doesn’t tell the whole story.
That’s where DuPont analysis comes in – it uncovers how a company achieves its ROE, helping you spot strengths, weaknesses, and potential risks.
DuPont analysis – what are the three drivers of ROE
The most used version of DuPont analysis splits ROE into three components.
ROE = Net Profit Margin x Asset Turnover x Financial Leverage
By breaking it down, you can see what’s really driving a company’s profitability.
Is it operational efficiency, asset management, or simply a lot of debt?
This insight is invaluable for making informed investment decisions.
Net Profit Margin
How much profit a company makes from each unit of sales (revenue). A high profit margin means the company efficiently turns sales into profit.
Net Profit Margin = Net Income / Revenue
Asset Turnover
How effectively a company uses its assets to generate sales. A high asset turnover indicates the company squeezes more revenue from its assets.
Asset Turnover = Revenue / Avg. Total Assets
Financial Leverage
How much debt a company uses to finance its operations. Higher leverage can boost returns, but also increases risk.
Financial Leverage = Avg. Total Assets / Avg. Shareholders' Equity
How does DuPont analysis work in practice?
Imagine two companies, both with an ROE of 15%.
At first glance, they seem equally attractive.
But DuPont Analysis reveals a different picture:
Company A
Profit Margin: 10%
Asset Turnover: 1.5
Financial Leverage: 1.0
ROE = 10% x 1.5 x 1 = 15%
Company B
Profit Margin: 5%
Asset Turnover: 1.0
Financial Leverage: 3.0
ROE = 5% x 1 x 3 = 15%
Company A generates solid profits from sales and uses its assets efficiently, with no debt. Its ROE comes from strong operations. But when we turn to Company B, we see it has lower profitability and asset efficiency, but achieves the same ROE by using significant debt. Its high leverage amplifies returns – but also risk.
By revealing the drivers behind ROE, it helps you spot companies with sustainable profitability and avoid those propped up by debt.
Add this tool to your investment toolkit, pair it with other analyses, and you’ll be better equipped to build a resilient portfolio.
Applying DuPont to two shares to watch
NVIDIA
NVIDIA’s dominance in recent years has been impressive, as we can see from the significant rise in ROE below. It makes for a great example to put DuPont to the test, but of course there are no guarantees it will continue
NVIDIA ROE breakdown
Breaking out the component parts, we can see all three ROE elements improving from 2022/23 levels as NVIDIA’s artificial intelligence (AI) chips became the hottest piece of hardware to own.
A fall in financial leverage has been more than offset by improvements in net margin and asset turnover. All in, that’s a recipe for strong performance and tracks with what we know about NVIDIA.
Its powerful chips now fuel the training and deployment of the most advanced models, enabling everything from natural language processing to robotics. As demand for AI applications has increased, so has the need for the high-performance computing NVIDIA delivers.
What sets NVIDIA apart is not just its hardware dominance, but the full-stack ecosystem it’s built around it. Its software platforms and developer tools make it easier for companies to scale AI applications quickly and efficiently.
This end-to-end approach has made NVIDIA a cornerstone in a market where speed, efficiency, and scalability are paramount.
But competition is growing, and the DuPont analysis shows that analysts expect growth in some of these growth measures to start to settle over the coming year.
Read NVIDIA’s latest results and our longer-term view below.
The author holds shares in NIVIDIA.
Unilever
Consumer goods giant Unilever has a very different profile to what we’ve just seen with NVIDIA.
Unilever ROE breakdown
The first thing to stand out is the consistency of returns, ROE has been broadly flat for the past few years – a reflection of the steady performance you tend to get from a consumer goods company.
Leverage is a much bigger factor in the ROE equation too, but that’s not necessarily an issue.
As a very mature business, in a relatively stable sector, Unilever can stomach higher debt than giant tech names. This is an example of where tying in the numbers with knowledge of the business can help.
Margins slowly crept higher last year and are expected to stay at that level for the current year too. Unilever is in the midst of a turnaround, with management and portfolio changes underway to help reignite growth.
These fundamentals look robust – add in the new focus and we’re supportive of the investment case for Unilever. But there’s a softer market to contend with and there’s plenty of execution risk ahead.
Read Unilever’s latest results and our longer-term view below.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by LSEG. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss. Yields are variable and not guaranteed.
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