DuPont Identity [LO3] Why is the DuPont identity a valuable tool for analyzing the performance of a firm? Discuss the types of information it reveals compared to ROE considered by itself.
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Return on equity is probably the most important accounting ratio that measures the bottom-line performance of the firm with respect to the equity shareholders.
The Du Pont identity emphasizes the role of a firm’s profitability, asset utilization efficiency, and financial leverage in achieving an ROE figure. For example, a firm with ROE of 20% would seem to be doing well, but this figure may be misleading if it were marginally profitable (low profit margin) and highly levered (high equity multiplier). If the firm’s margins were to erode slightly, the ROE would be heavily impacted.