ROE DuPont Analysis 3-component decomposition of ROE (return on equity)Here is some additional information regarding ratio analysis, in particular, a common technique of decomposing the ROE into 3 core components.Also, there is an additional question regarding ratios at the bottom.

(Note:Pages 46-48of text provides the 3 component ROE DuPont Decomposition.)

3-component decomposition of ROE (return on equity)(aka DuPont Analysis of ROE)

ROE is commonly defined as [net income]/[equity]=NI/E.

ROE is commonly decomposed into 3 components to see what is contributing to the ROE result.The decomposition is as follows:

ROE=(NI / S) X (S / TA) X (TA / E)

(Notice sales cancel, & total assets cancel; giving net income/equity, the ROE result.

or in terms of 3 common ratios:

ROE=(profit margin) X (total asset turnover) X (financial leverage multiplier)

and, in terms of what the 3 ratios measure:

=(operating efficiency ) X ( asset utilization ) X ( debt usage )

Thus:Say 2 firms both have ROE = 25%,and decomposing the ROE gives:

FIRM A:ROE=( 5% ) X ( 1.6 ) X ( 3.125 )

FIRM B:ROE=( 10% ) X ( 2.0 ) X ( 1.25 )

Given this decomposition of ROE, which firm would you prefer?Why?

Would you ever use the ROE decomposition to"compute"ROE?

What would you use it for?