Since operational performance measures are more or less obvious, in this section we will restrict ourselves to going into greater detail only about the DuPont Analysis system.

The DuPont Analysis system allows a quick overview of the main components of a company's Return on Equity (ROE), by subdividing it into items that can be analyzed separately. On this website we currently have the information to analyze the RPL in 2 or 3 components, according to the formulas below:

2 components: Financial Leverage (FL) and Return on Assets (ROA)

RPL = FL x ROA (*2)

3 components: Financial Leverage (FL), Asset Turnover (A/T), and Net Margin (N/M)

RPL = FL x A/T x N/M (*3)

(*2) Given that TA = Total Assets; PL = Net Equity; LL = Net Profit; RL = Net Revenue, AF = AT / PL; RA = LL / AT –> AF x RA = (AT / PL) x (LL / AT) = LL / PL = RPL.

(*3) Given that AT = Total Assets; PL = Net Equity; LL = Net Profit; RL = Net Revenue, AF = AT / PL; GA = RL / AT ; ML = LL / RL –> AF x GA x ML = (AT / PL) x (RL / AT) x (LL / RL) = LL / PL = RPL.

The division into 3 components can be seen as simply the same as the division into 2 components , but separating the Return on Assets into two fundamental components: Asset Turnover and Net Margin.

Return on Equity

The Return on Equity is a very important measure for the investor, because it indicates how much profit that company is able to generate for each unit of "investment" in its net equity. In other words, the higher this return, the better, if the other conditions were kept constant. A simple, and perhaps more intuitive, way to think about the RPL is to think as if the investment were in fixed income, instead of variable income. IF a company's historical RPL remains constant in the future and IF the share price completely reflects the behavior of its net income and IF the share price relative to its net income remains constant (big "IFs", but remember that at this point we are just simplifying to make the concept more intuitive), then investing in a stock of a company with a RPL of 30% per year will be better than investing in a stock of a company with a RPL of 20% per year and will also be better than investing in a fixed income instrument yielding 15% per year.

Remembering that we are obviously always looking at historical data in the information displayed on this site, what we want to be sure of when we analyze a company is that the RPL will be high in the future. In this regard, the breakdown of the historical RPL can help in the analysis of that specific company in two different ways: - Low historical RPL: ​​given the historical characteristics that led that company to have a low RPL, is there any change underway in the company or in its market that leads us to believe that any of the components of the RPL will change in the future within our investment horizon in a way that increases the value of the RPL? - High historical RPL: ​​given the historical characteristics that led the RPL to have a high level, are the future conditions of the company or its market such that they will allow the RPL to remain at a high level throughout our investment horizon?

Another way to look at the evolution of the RPL and its components is by making a comparison between two or more companies, preferably those that operate in the same sector. This way we can verify whether a company's RPL is in line with what would be expected for its sector of activity, and, if not, what are the main causes of this disparity.

Breaking down the RPL into its components allows us to better analyze how successful (or not) the company's management is in extremely important points.

Net Margin

The Net Margin provides a measure of the company's profitability, and therefore it is an index that is always preferable to be higher and increasing. It gives us an idea of the percentage of net revenue that is "left over" after all operating costs are paid.

A company that is increasing its net margin is most likely managing to charge more for each product/service it sells, spend less to produce what it sells, increase the general level of efficiency of its operation even in items not directly related to the production of what is sold (in central administration, or in the management of investment of surplus cash or financing of necessary capital, for example), or eliminate lines of business that are not very profitable or not at all if it is a multi-product/multi-service company.

All of this is positive news for the shareholder, since it indicates that the product/service produced has a growing demand and probably a competitive edge, that the company's management cares about efficiently managing its fixed costs, and that, if the company has several different product/service lines, it is managing each one separately to ensure that they all stand on their own two feet. The opposite is also true, and therefore decreasing and/or low margins need to be analyzed carefully.

The level of the net margin (high, low) can also give us an indication of the level of competition in the sector in which the company operates. High margins are more common in sectors with little competition, in companies that have some type of important competitive edge in relation to the competition, and therefore have the power to price their products/services well in order to have a good margin.

Asset Turnover

Asset Turnover provides a measure of the efficiency in the management of the company's assets, and therefore it is an index that is also preferable to be higher and increasing.

A company that is increasing its turnover is using its assets more efficiently, that is, it is using the same assets it had to produce more sales than before, or, equivalently, it is using fewer assets to produce the same level of sales. This is good news for the shareholder as less of the company's capital needs to be "tied up" in assets to produce the same level of sales. This is the case, for example, of a retailer that implements processes/systems to better manage inventory, allowing it to have a smaller inventory to meet the same sales it had before. In this case, the company has the option of using the “excess” capital to increase sales levels (if there is demand for this), or of returning it to the shareholder in the form of higher dividends in the next distribution, for example.

It is worth remembering that from the shareholder’s point of view, a high turnover does not necessarily imply a high return, just as a high net margin, in isolation, does not either. From the shareholder’s point of view, what matters is the combination of the two effects, together with financial leverage (described in more detail in the next item), so that the Return on Equity is high, or high enough. It is very common for businesses that have high asset turnover to have low net margins and vice versa. For example, businesses that have a competitive edge due to a very high entry cost ("entry barrier") tend to have a high net margin in view of their competitive positioning, but at the price of having many assets "stuck" in the business and therefore a low asset turnover.

The product of Asset Turnover with Net Margin provides the Return on Assets of a company, and as we concluded individually from the analysis of each one, it is better for it to be higher and increasing.

Financial Leverage

Financial Leverage gives us a measure of the level of debt used by the company, and therefore, unlike the other 2 previous ratios, despite increasing the NPL, it is not an index that we would always prefer to be higher and growing. At the same time, it is not necessary for the level of debt to be zero.

As can be seen from the Return on Equity formula, the higher the Financial Leverage, the higher the NPL. This would always be true if an opposite effect did not occur. Every time the level of debt increases, the business risk also increases. This is because a company with more debt first increases its financial cost, which is basically a fixed cost. Additionally, this makes the company more vulnerable in periods of underperformance, and therefore increases the chance of the company going bankrupt or liquidating. Ultimately, if the company goes through a lot of difficulties and needs to be liquidated, a larger amount will need to go to the creditors (who lent money to the company) before any capital can begin to be returned to the shareholders. A company with low financial leverage will always be less risky than a company with high financial leverage, keeping the other factors of analysis constant.

Due to these characteristics, highly cyclical companies (more subject to the economic cycle in general, that is, they sell much less in an economic recession, for example) normally have lower leverage than companies with little cyclicality.

Therefore, from the company's management point of view, it is always interesting to observe whether the RPL is not being kept high or increasing in an “artificial” manner by an excessive increase in its financial leverage. If used in a balanced and prudent manner, financial leverage can improve the RPL, without considerably increasing the shareholder's risk.