Academic journal article Management Accounting Quarterly

A Decade of DuPont Ratio Performance

Academic journal article Management Accounting Quarterly

A Decade of DuPont Ratio Performance

Article excerpt

A popular framework for foundational financial analyses, the DuPont financial ratio model has been called "a timeless and elegant model of financial analyses." (1) It also has been called "a veritable gold mine of information about a firm's return on equity [since it deconstructs] profitability into constituent parts, examining margin, turnover, and capital structure." (2) Perhaps more than any other decade during the tenure of today's managers, the years 2000 to 2010 were unprecedented in their tumult and challenges. Besides the landmark events in the geopolitical arena, the business world tackled its own Whitewater. Downsizing, lean, outsourcing, restructuring, benchmarking, and a host of other mantras dominated the operations business landscape. In parallel, issues such as shareholder return, credit crunches, incentive compensation, recession, and performance measurement occupied the financial mindset of many corporate leaders. The question of interest arising from these factors is, "How have the values for the five DuPont ratios changed?"

To begin to answer that question, this study identi fies the changes that occurred in the DuPont ratios during the first decade of the 21st Century for a sample of 130 publicly traded U.S. companies occupying 22 industry groups, per their Fortune 500 listing. (3) To highlight industry differences for the DuPont ratio changes, this article reports the average:

* Fiscal year 2000 level of the DuPont ratios,

* Respective compound annual growth rate (CAGR) or decline rate during the ensuing decade,

* Fiscal year 2010 levels, and

* Changes in the relative contribution each part of the model made to the return on equity (ROE) ratio.

Several cautious uses can be made of these insights. First, the data provides benchmarking opportunities for companies operating in each industry group. Second, the data also shows patterns as to how industries evolved along certain financial dimensions over those 10 years in the face of a rapidly and powerfully changing business landscape. Third, the changes in the DuPont ratios offer an opportunity for comparison with four other fundamental financial performance metrics (sales, net income, earnings per share, and sales per employee) during that same period. Fourth, the 10-year CAGRs for the DuPont ratios are correlated with total shareholder returns in order to observe their possible usefulness in anticipating future shareholder returns.

A Quick Refresher on the DuPont Model

The basic DuPont model is composed of five financial ratios: return on sales (ROS), asset turnover (ATO), return on assets (ROA), financial leverage (FinLev), and, of course, return on equity (ROE). Their general definitions are:

ROS = net income/net sales

ATO = net sales/total assets

ROA = net income/total assets

FinLev = total assets/total owners' equity

ROE = net income/total owners' equity

The model's elegance is resident in the multiplicative relationship among the component parts. As a reminder, recall that:


ROA x FinLev = ROE and thus

ROS x ATO x FinLev = ROE

In short, the ROS part of the model sheds light on a company's pricing power and cost containment. ATO highlights asset efficiency and leanness, while FinLev provides insights regarding a company's cautious or aggressive use of borrowed funds. And ROE is "a good metric for overall performance" (4) and "a crucial test of management effectiveness." (5)

A Decade of DuPont Data Insights

Table 1 shows the average level of the five DuPont rations as of 2000 and 2010 for each of the 22 industry clusters. A general pattern in CAGRs emerges from that data, as shown in Table 2. Four observations can be made from these findings.

First, ATO got worse for 10 of the 22 industries; it stayed about the same for another 10. …

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