DuPont analysis: where ROE comes from
Target's return on equity fell from 29% to 24%. Split it into margin, turnover and leverage to find out why, and how much of what's left is real.
FinanceReading the accounts like an analystAbout 10 min: 9 reading, 1 practiceUpdated
General education, not financial advice.
- Break ROE into net margin, asset turnover and the equity multiplier
- Explain which parts drove a change in ROE
- Say what evidence would change your reading of a company's returns
Builds toward: Judge a company. Read a company's accounts, apply Graham's tests, and make a rough valuation.
Reading the accounts like an analyst: lesson 5 of 5
- Reading the accounts like an analyst
- The three statements and how they link 10 min
- Common-size statements and trends 9 min
- Profitability ratios: margins, ROA and ROE 9 min
- Efficiency ratios and the cash conversion cycle 9 min
- DuPont analysis: where ROE comes from 10 min
Pairs with any financial statement analysis text (the chapter on return on invested capital and its components)
Mission
From: the chair of an investment committee Due: next Monday's meeting
Target's return on equity dropped from about 29% to 24% last year. Before Monday, give me a half-page note: what drove the fall (selling less, earning less per sale, or financing?), and is 24% as good as it looks? Use the 10-K for the year to 31 January 2026.
The documents (Target's 10-Ks; millions of dollars; the 2024 year ended 1 February 2025, the 2025 year 31 January 2026):
| 2024 | 2025 | |
|---|---|---|
| Net sales | 106,566 | 104,780 |
| Net earnings | 4,091 | 3,705 |
| Assets, start → end | 55,356 → 57,769 | 57,769 → 59,490 |
| Equity, start → end | 13,432 → 14,666 | 14,666 → 16,165 |
From the 2025 report: net earnings include an after-tax gain of 441 from interchange fee settlements and after-tax business transformation costs of 187. Target's adjusted diluted EPS, which excludes both, was 7.57 against reported 8.13.
What it is
The toolkit for this job.
The DuPont analysis is named after the chemical company where, early in the 20th century, it was first used to split return on investment into margin × turnover. The usual modern version adds a third part, leverage, to explain ROE:
ROE = net margin × asset turnover × equity multiplier
- Net margin = net income ÷ revenue: how much of each sale is kept.
- Asset turnover = revenue ÷ average total assets: how much is sold for each unit of assets.
- Equity multiplier = average total assets ÷ average equity: how many units of assets each unit of the owners' money supports. The higher it is, the more the assets are funded by debt and other liabilities (leverage).
Revenue and assets cancel out, leaving net income ÷ equity. Margin × turnover is ROA, so ROE = ROA × equity multiplier.
Before you start
You've done this kind of job four times now. Before you open the model answer, write down your first three checks on Target's figures, and what result from each would change your reading. Then compare them with the expert's.
Why it matters
The same ROE can come from very different businesses: a luxury brand earns it from margins, a discount retailer from turnover, a bank from leverage. The first two are about how well the business runs; the third raises both the return and the risk. When ROE moves, DuPont tells you whether the business changed or only its financing.
Worked example
Two imaginary companies, Northgate Grocers and Brightline Software, both with an ROE of 18%:
| Northgate | Brightline | |
|---|---|---|
| Net margin | 2% | 20% |
| Asset turnover | 3 | 0.6 |
| Equity multiplier | 3 | 1.5 |
| ROE | 18% | 18% |
Northgate keeps little from each sale but sells a lot for its assets, and is more leveraged. If its margin slipped from 2% to 1%, its ROE would halve to 9%; if its multiplier rose to 4, ROE would rise to 24% with no improvement in the business at all.
Common mistake
Treating a rising ROE as good news without asking which part rose. If the multiplier did the work (more borrowing, or buybacks shrinking equity), the business hasn't improved; it has become riskier. Always show all three parts, for at least two years.
More detail: the five-part version
The five-part DuPont splits net margin further:
ROE = (net income ÷ pre-tax profit) × (pre-tax profit ÷ operating profit) × (operating profit ÷ revenue) × asset turnover × equity multiplier
The first two are the tax burden and the interest burden. Both are usually 1 or less; the interest burden can go above 1 when interest income and other gains exceed interest cost (Costco's, for example, is about 1.05). For an imaginary company with net income 150, pre-tax profit 200, operating profit 240, revenue 2,000, turnover 1.33 and multiplier 2.5: 0.75 × 0.83 × 12% × 1.33 × 2.5 = 25%. This shows whether ROE moved because of the business or because of tax and interest.
Analysts often go further and separate the operating business from its financing: return on net operating assets (operating profit after tax over the assets used in operations, less operating liabilities such as payables), plus a leverage effect from net debt.
Key terms
- DuPont analysis
- splitting ROE into net margin × asset turnover × equity multiplier
- equity multiplier
- average total assets ÷ average equity; a measure of leverage
- leverage
- using borrowed money and other liabilities to fund assets, which magnifies returns and losses
- tax burden
- net income ÷ pre-tax profit
- interest burden
- pre-tax profit ÷ operating profit
Practise the key terms
Tap a card to turn it over. 5 cards.
| Front | Back |
|---|---|
| DuPont analysis | splitting ROE into net margin × asset turnover × equity multiplier |
| equity multiplier | average total assets ÷ average equity; a measure of leverage |
| leverage | using borrowed money and other liabilities to fund assets, which magnifies returns and losses |
| tax burden | net income ÷ pre-tax profit |
| interest burden | pre-tax profit ÷ operating profit |
Task
Write the half-page note for the committee chair:
- a DuPont table for both years, checked against ROE worked out directly;
- which parts drove the fall, in business terms;
- the 2025 ROE with and without the one-off items;
- what result next year would change your reading.
Model answer
Show the model answer
| 2024 | 2025 | |
|---|---|---|
| Net margin | 3.84% | 3.54% |
| × Turnover | 1.88 | 1.79 |
| × Multiplier | 4.03 | 3.80 |
| = ROE | 29.1% | 24.0% |
Workings, 2025: average assets (57,769 + 59,490) ÷ 2 = 58,629.5; average equity (14,666 + 16,165) ÷ 2 = 15,415.5. Margin 3,705 ÷ 104,780 = 3.54%; turnover 104,780 ÷ 58,629.5 = 1.79; multiplier 58,629.5 ÷ 15,415.5 = 3.80; directly, 3,705 ÷ 15,415.5 = 24.0%. 2024 likewise: averages 56,562.5 and 14,049.
Without the one-offs: 3,705 − 441 + 187 = 3,451; margin 3.29%; ROE 3,451 ÷ 15,415.5 = 22.4%.
Target: a smaller business earning less per sale, with less leverage · Source: Forms 10-K for the years to 1 February 2025 and 31 January 2026
All three parts fell. The biggest was the margin: Target kept 3.5 cents of each dollar of sales against 3.8 cents. Sales also fell while assets grew, so each dollar of assets produced less (turnover 1.79 against 1.88). And equity grew faster than assets as profits were retained, so leverage eased (3.80 against 4.03), which lowered ROE but also lowered risk.
24% flatters 2025. Net earnings include a 441 after-tax settlement gain, partly offset by 187 of transformation costs. Without both, net margin is 3.3% and ROE about 22%: the underlying fall was from 29% to 22%, not 24%.
What would change my reading: a recovery in margin with flat assets would show the 2025 fall was temporary; further falls in turnover would show the growing asset base isn't producing sales. If ROE recovers only through a higher multiplier (for example, buybacks funded by debt), that is financing, not a better business.
How the expert gets there. Their first three checks: (1) do the parts multiply back to the ROE worked out directly? (2) which part moved most, and is it about the business or its financing? (3) is anything one-off inside net earnings? They check that the parts multiply back to the direct ROE, which catches mistakes in averages. They translate each ratio into a business sentence (sold less per unit of assets; kept less per sale). They strip out the one-offs using the company's own after-tax figures, and they set out in advance what next year's numbers would prove them wrong.
What a reviewer would flag:
- Reporting the reported 24% without the one-off adjustment.
- Treating the lower multiplier as bad news: less leverage lowers ROE but makes it safer.
- Ratios on year-end balances, which don't match how profit is earned over the year.
- No test of the conclusion: "what would change my mind" missing.
Practice
Work it through
Warm-up. A clothing chain's net income is 240 on revenue of 4,800, with average total assets of 3,200 and average equity of 1,280. Next year it borrows 480 at 5% interest to buy back shares, so average equity falls to 800 while assets, sales and operating profit stay the same. Its tax rate is 25%.
- 240 ÷ 1,280 × 100 (margin 5% × turnover 1.5 × multiplier 2.5)
- 480 × 5% = 24; 24 × (1 − 0.25)
- (240 − 18) ÷ 4,800 × 100
- 3,200 ÷ 800
- 4.625% × 1.5 × 4, or 222 ÷ 800
Transfer: did the business improve? Walmart's ROE rose from 22.2% (year to 31 January 2025) to 23.0% (year to 31 January 2026). From its Form 10-K for 2026 (millions): total revenues 680,985 and 713,163; net income attributable to Walmart 19,436 and 21,893; total assets 252,399 (January 2024), 260,823 (2025) and 284,668 (2026); Walmart shareholders' equity 83,861, 91,013 and 99,617. Open the 10-K before you answer. In three sentences: did the business improve, and what would change your mind?
A model answer
Not on the evidence: the rise in ROE comes from an investment gain, not from the shops. The DuPont parts are margin 2.85% → 3.07%, turnover 2.65 → 2.61 and multiplier 2.93 → 2.86, so only the margin rose; but "other (gains) and losses" swung from a 794 million loss to a 2,075 million gain, mainly fair-value changes on equity investments. Taking both out at each year's effective tax rate (23.4% and 24.4%) gives net income of about 20,044 and 20,324, a margin falling from 2.94% to 2.85%, and ROE falling from about 22.9% to 21.3%. What would change my mind: operating margin rising in a year without investment gains, or turnover recovering as the year's new assets start producing sales.
How the expert gets there: when only the margin moved, they go to the income statement to see which line moved it, and find a non-operating swing.
What a reviewer would flag: "ROE rose, so the business improved"; adjusting only one of the two years; forgetting tax when removing the gain and loss.
In short
- ROE = net margin × asset turnover × equity multiplier; margin × turnover = ROA.
- Check that the parts multiply back to the direct ROE.
- Translate each part into what happened in the business.
- A higher ROE from a higher multiplier means more risk, not a better business.
- Strip out one-offs and say what next year's results would change your mind.
Check yourself
Answer in your head first, then open the answer. Nothing is saved.
ROA is 8% and the equity multiplier is 2.5. What is ROE?
Show answer
20%.
In the warm-up, ROE rose from 18.75% to 27.75%. Did the business improve?
Show answer
No: turnover didn't change and the margin fell because of the new interest; the rise came from more leverage, which also raised the risk.
Two companies both have an ROE of 20%. What would you look at to tell them apart?
Show answer
Their margin, asset turnover and equity multiplier, and how each has changed over time.
Further reading
- Target Corporation, Forms 10-K for the years ended 1 February 2025 and 31 January 2026 (SEC EDGAR): statements of operations, balance sheets, and the reconciliation of non-GAAP adjusted EPS.
- Corporate Finance Institute, Financial Analysis Glossary (DuPont analysis).
- On this site: Profitability ratios: margins, ROA and ROE; Efficiency ratios and the cash conversion cycle.
- Case study: Two retailers, two routes to a high return.
Finished? Mark it done to fill in your leaf on the Finance map.