What is the Dupont method? This is a stock analysis model that helps to see the correlation between the indicators to ROE and the causes of the index's fluctuations.
What is the Dupont method?
Dupont model method (Dupont Analysis) is a basic method used to evaluate a company's profitability through financial indicators, especially the ROE (Return on Equity) index - this is the rate of return on equity.
ROE is an important indicator for stock investors, helping them identify businesses that are capable of using capital effectively in both the short and long term. From there, investors can find potential stocks with growth potential, thereby choosing good stocks to increase efficiency. investment knowledge.
Formula for calculating ROE using the Dupont method
The basic formula for calculating ROE can be expressed as follows:
ROE = Net Income x Total Asset Turnover x Equity Ratio
Or: ROE = (Profit after tax / Average owner's equity) x 100%
Or: ROE = Net profit margin x Asset turnover x Financial leverage
For investors, the profit ratio is an extremely important factor in evaluating the performance of a business. Therefore, the ROE index is one of the most important indicators. Because equity is a part of the total capital forming assets, the ROE index will be affected by the profit ratio on total assets.
To improve ROE, managers can take the following measures:
- Adjust debt and equity ratios to match the company's performance.
- Increase asset utilization by improving asset turnover.
- Find ways to increase net revenue, reduce costs, improve product quality to increase profits.
Accordingly:
- Earnings: If the company has subsidiaries, this is the total after-tax profit of the parent company's shareholders.
- Average equity: Is the total capital of shareholders, including charter capital, undistributed profits after tax and other items.
What are the advantages and disadvantages of the Dupont method?
Advantages of use What is the Dupont method?? That is to analyze the growth potential of the business including:
- Simple formulas make calculating and analyzing metrics easy.
- This model helps to clearly identify the indicators that affect ROE, from which important indicators can be focused on for monitoring and improvement.
- Based on Dupont equation, businesses can identify areas for improvement such as increasing profit margins by reducing costs, raising selling prices to increase revenue, using appropriate financial leverage to develop or effectively managing assets to ensure sustainable growth.
However, the analysis using the DuPont method model also has some limitations. The biggest limitation is the dependence on accounting equations and basic data. If the accounting data is inaccurate or unreliable, the analysis results may be biased and lead to incorrect judgments.
Real life example of Dupont model method
Dupont method example Reality in FPT and Viettel analysis:
When applying Dupont analysis to FPT Corporation in the first, second and third quarters of 2021, investors have the following information:
- Net profit margin = Profit after tax (VND 3,786 billion) / Revenue (VND 24,953 billion)
- Asset turnover = Revenue (VND 24,953 billion) / Total assets (VND 13,970 billion)
- Financial leverage = Total assets (VND 13,970 billion) / Average equity (VND 60,112 billion)
Calculate FPT's ROE in the first 9 months of 2021:
ROE = 0.152 x 0.179 x 2.324 = 0.063 (6.3%)
Compared to Viettel's ROE in the same period:
ROE = 0.016 x 1.073 x 3.729 = 0.064 (6.4%)
From this analysis, investors can draw the following information:
- FPT's net profit margin is higher than Viettel's.
- FPT's asset turnover is lower than Viettel's.
Thus, using the Dupont model in this case helps investors compare two businesses at the same time. The Dupont model is also very effective when applied to evaluate the indicators of the same business over the years.
Example with Hoa Phat: The Dupont model can be used to analyze the ROE of Hoa Phat Group in the period from 2016 to 2020, with the following Company financial statement analysis as follows:
| Dupont | 2016 | 2017 | 2018 | 2019 | 2020 |
| Profit after tax/before tax | 0.86 | 0.86 | 0.85 | 0.83 | 0.88 |
| Profit before tax/EBIT | 0.96 | 0.95 | 0.95 | 0.91 | 0.87 |
| EBIT/Revenue | 0.24 | 0.21 | 0.19 | 0.16 | 0.19 |
| Total Asset Turnover (Revenue/Total Assets) | 1.13 | 1.07 | 1.85 | 1.71 | 0.77 |
| Total Assets/Owner's Equity (Financial Leverage) | 7.71 | 1.65 | 1.8 | 2.04 | 2.18 |
| ROE | 0.39 | 0.31 | 0.24 | 0.17 | 0.25 |
Hoa Phat's projects have benefited from the government's tax incentives for a long time. The ratio of pre-tax profit to after-tax profit is always higher than 0.85, showing that Hoa Phat's (HPG) tax rate is lower than 15%.
Net profit margin in 2016 was higher than in other years, mainly due to the increase in raw material prices of iron ore and coal, leading to a sharp increase in the company's revenue and profit.
From 2017 to 2020, Hoa Phat's profit margin gradually decreased, but from 2022 this index began to show signs of recovery.
Regarding asset turnover, in 2017-2018, Hoa Phat Group mobilized up to 30,000 billion VND to invest in two Iron and Steel Complex projects. By 2020, the company's revenue had increased by 40%.
Regarding financial leverage, Hoa Phat has been using more and more leverage over the years. However, with its high reputation and good growth rate, the company's use of financial leverage can be considered quite effective.
Although Hoa Phat's ROE ratio has been decreasing over the years, this does not mean that the company is operating inefficiently. It is necessary to monitor financial reports and analyze them in detail. Dupont ROA method to assess the impact factors. A decrease in ROE may be due to the company expanding production or decreasing revenue due to large investment costs. However, when new factories come into operation, the growth rate will be a signal for a recovery in ROE in the future.
What are the conditions for applying the Dupont method?
The most important condition when evaluating a business according to What is the Dupont method?? That is the input data must ensure accuracy and reliability. However, accounting data can sometimes be adjusted by businesses or "beautified" financial reports to attract the attention of investors.
Some common tricks used to beautify financial statements include: reducing costs through capitalization, recording fictitious revenue, omitting or incorrectly setting aside provisions for asset impairment, accounting for the wrong accounting period, changing depreciation methods, or recording lower-than-actual liabilities.
Steps for effective and quick Dupont analysis
Analysis by Dupont equation Helps managers and investors identify relationships between financial indicators, thereby determining factors affecting the analysis indicators in a clear order.
The steps of Dupont analysis are as follows:
- Step 1: Collect business data from financial reports along with information related to production, sales and other factors.
- Step 2: Enter the collected data into the spreadsheet to calculate using the Dupont formula.
- Step 3: Draw conclusions about the factors affecting business operations.
- Step 4: Check and analyze the data again to ensure accuracy and reliability.
Above HVA shared basic information about What is the Dupont method?, hope to help you better understand Dupont analysis as well as the steps to perform and Purpose of the Dupont methodThis will assist you in finding efficient businesses to make optimal investment decisions.
