Returns tell you how well a company uses the money given to it; the DuPont split tells you why.
Two returns every manager should know
Margins tell you how much profit a company makes on each ₹100 of sales. Returns tell you how much it makes on each ₹100 of money invested in it. A business can have thin margins and excellent returns (a supermarket), or fat margins and poor returns (a luxury hotel that needed huge buildings).
| Return | Formula | Question it answers | Vardhan |
|---|---|---|---|
| Return on equity (ROE) | Profit after tax ÷ equity | What do the owners earn on their money? | 17.5% |
| Return on capital employed (ROCE) | EBIT ÷ (equity + borrowings) | What does the business earn on all the long-term money in it? | 20.0% |
| Return on assets (ROA) | Profit after tax ÷ total assets | How productive is everything it owns? | 10.4% |
Which return for which question
| You are… | Use | Because |
|---|---|---|
| A shareholder or investor | ROE | It is your return, after lenders are paid |
| A business head judging a unit | ROCE (or return on segment assets) | Funding decisions are made elsewhere; judge the operations |
| A lender | ROCE and interest cover | You want the business to earn well above the interest rate |
| Comparing companies with different debt | ROCE | ROE would reward the most borrowed company |
| Judging a bank or NBFC | ROE and return on assets | Debt is their raw material, not a choice |
Return on assets is useful for asset-heavy businesses and for banks, but for most companies ROE and ROCE together tell the story.
The DuPont split
In the 1920s, managers at the DuPont company in the US used a simple identity to understand their returns. Return on equity can be written as three ratios multiplied together:
| Driver | Formula | Question | Vardhan |
|---|---|---|---|
| Profit margin | PAT ÷ revenue | How much profit per ₹100 of sales? | 8.4% |
| Asset turnover | Revenue ÷ total assets | How many rupees of sales per rupee of assets? | 1.23× |
| Leverage | Total assets ÷ equity | How many rupees of assets per rupee of owners' money? | 1.69× |
| ROE | Multiply the three | 17.5% |
Revenue cancels with revenue and total assets with total assets, so the three multiply back to PAT ÷ equity. Check: 8.4% × 1.23 × 1.69 ≈ 17.5%.
Three routes to the same kind of ROE
Here are the three companies through the DuPont lens. Their ROEs don't look wildly different. Their routes are.
| Year 2 | Profit margin | Asset turnover | Leverage | ROE |
|---|---|---|---|---|
| Vardhan Kitchenware | 8.4% | 1.23× | 1.69× | 17.5% |
| Prakash Appliances | 7.1% | 1.33× | 1.73× | 16.4% |
| Shree Steelcraft | 3.3% | 0.90× | 3.33× | 10.0% |
- Vardhan earns its return through margin. Strong brands and its own factories give it the best margin of the three.
- Prakash earns it through turnover. Lower margins, but it outsources manufacturing, so it needs fewer assets for each rupee of sales.
- Shree leans on debt. Weak margin and slow-moving assets give a return on assets of only 3%; leverage of 3.33× lifts that to a 10% ROE, at a heavy cost in risk.
Notice that the ranking by ROE (Vardhan, Prakash, Shree) is not the ranking by risk. Prakash reaches almost the same ROE as Vardhan with far less debt, as Chapter 5 shows.
The five-step DuPont
For a deeper look, split the profit margin further into tax, interest and operations. This shows exactly where profit leaks out between operating profit and the owners.
| Step | Formula | Vardhan | Shree |
|---|---|---|---|
| Tax burden | PAT ÷ PBT | 0.75 | 0.75 |
| Interest burden | PBT ÷ EBIT | 0.85 | 0.47 |
| EBIT margin | EBIT ÷ revenue | 13.2% | 9.4% |
| Asset turnover | Revenue ÷ total assets | 1.23 | 0.90 |
| Leverage | Total assets ÷ equity | 1.69 | 3.33 |
| ROE | Multiply all five | 17.5% | 10.0% |
Shree's interest burden of 0.47 says it all: interest takes more than half of its operating profit (EBIT ₹17 cr, interest ₹9 cr). Its operating business, with a 9.4% EBIT margin, isn't bad. Its financing is the problem.
Questions from the worksheet: A DuPont split
Fill in your company and two peers. Then circle the driver that explains most of the difference in ROE.
Columns in the worksheet: Company · PAT margin · Asset turnover · Leverage · ROE · Main driver
What to remember
- ROE is the owners' return; ROCE is the business's return on all long-term capital.
- DuPont splits ROE into margin × asset turnover × leverage, which shows why returns differ.
- A return is good only if it beats the cost of the money used to earn it.
- ROCE
- EBIT ÷ (equity + borrowings): return on all long-term capital.
- DuPont split
- ROE = profit margin × asset turnover × leverage.
- Spread
- Return minus the cost of capital.
This article is adapted from the book. Examples marked “Example” use invented names and numbers; company stories are based on public sources listed in the book. Education only: not investment, tax or legal advice.
