DuPont Analysis: Breaking Down Return on Equity

Introduction

Costco and Microsoft earned similar returns on equity in their latest fiscal years: about 28% and 34%. They got there in opposite ways. Costco kept 3 cents of net income from each dollar of sales but turned its assets over more than three and a half times a year. Microsoft kept 40 cents from each dollar but generated less than half a dollar of sales from each dollar of assets. Home Depot, with a margin between the two, reported a return on equity of about 146%, almost entirely because its balance sheet carries more than ten dollars of assets for every dollar of equity.

DuPont analysis is the tool that separates those three effects. It grew out of a formula devised at the DuPont company in 1914 by Donaldson Brown, a former explosives salesman who combined earnings, working capital and investment in plant into a single return on investment measure so that managers could compare very different businesses, as the Hagley Library's account of the father of ROI describes. A century later, it remains the quickest way to see what drives a company's returns.

Return on equity is net income divided by shareholders' equity. Multiplying and dividing by revenue and by total assets turns it into three ratios that each mean something on their own:

The first two together give return on assets, one of the measures compared in return ratios: ROE, ROA and ROIC; the third converts it into return on equity. A company can raise its return on equity by earning more on each sale, by selling more with the same assets, or by financing more of its assets with debt and other liabilities. Only the first two improve the business. The third makes the equity riskier, which is why the decomposition matters: the same return on equity can come from very different qualities of business.

Equity multiplier

Total assets divided by shareholders' equity, usually using averages for the period. It measures how many dollars of assets each dollar of equity supports, and so how much of the balance sheet is financed by liabilities. An equity multiplier of 3 means two-thirds of the assets are funded by debt and other liabilities.

Applying the formula to Costco, Microsoft and Home Depot, using average balances from their latest annual reports, shows how the three paths compare:

Costco's model is high turnover. Its warehouses carry a narrow range of goods that sell quickly, and the return comes from volume rather than margin, the trade-off explored in profitability margins. Microsoft's model is high margin on a large asset base: its balance sheet includes data centers, large holdings of cash and investments and goodwill from acquisitions, which hold turnover below one. Home Depot sits between the two on operations, with a return on assets of 14.1%, and its very high return on equity comes from leverage, the result of decades of share buybacks that have reduced its book equity to a small fraction of its assets.

Asset turnover

Revenue divided by average total assets for a period. It measures how many dollars of sales each dollar of assets generates. Retailers and distributors typically turn their assets over more than once a year, while utilities, telecom operators and capital-intensive manufacturers often turn them over less than once.

The Five-Factor Version

The extended version splits net margin into three parts. The tax burden, net income over pre-tax income, shows how much profit survives tax. The interest burden, pre-tax income over operating income, shows how much financing costs and other non-operating items take away, or add. And operating margin shows the profitability of the business before either. Multiplied by turnover and the equity multiplier, they give the same return on equity.

The extra detail can be revealing. Costco's and Microsoft's interest burdens are above one: their non-operating income exceeds their interest expense, from interest on Costco's cash and, for Microsoft, gains on its investment in OpenAI among other items, as its 2026 annual report shows. Home Depot's is 0.89, because interest on the debt that funds its buybacks and acquisitions takes about 11% of its operating income. A rising return on equity driven by a lower tax rate or a one-off investment gain is worth much less than one driven by a higher operating margin.

The decomposition is most useful in explaining changes. When a company's return on equity moves, DuPont analysis shows which factor moved. Home Depot's return on equity fell from about 385% to about 146% over its latest year. The business did not become less than half as profitable: its net margin slipped from 9.3% to 8.6% and its asset turnover from 1.85 to 1.64 times as it absorbed SRS and GMS, the distributors it acquired, taking return on assets from 17.2% to 14.1%. Most of the fall came from the equity multiplier, which dropped from about 22.5 to 10.3 times as equity grew while the company paused share repurchases.

Common Pitfalls

Three practical issues affect the results. Using closing rather than average balances distorts the ratios for companies whose assets or equity changed sharply during the year, as Home Depot's did after its acquisitions; averages match the balance sheet to the period over which the profit was earned. Negative or very small equity, the result of buybacks or accumulated losses, makes the equity multiplier and return on equity meaningless, and analysis then moves to return on assets or return on invested capital. And total assets include items unrelated to operations, such as excess cash and investments, which lower turnover without saying anything about efficiency.

A Version Built on Invested Capital

A variant built on invested capital avoids some of these problems. Return on invested capital can be written as operating margin after tax multiplied by capital turnover, revenue divided by invested capital, which keeps the logic of DuPont while excluding the effects of leverage and non-operating assets altogether. Home Depot's fiscal 2025 annual report shows its own version: net operating profit after tax of $15.9 billion on average debt and equity of $61.9 billion, a 25.7% return, or an after-tax margin of about 9.7% times capital turnover of about 2.7. Because debt counts as capital, that sits far below its 146% return on equity.

Bankers use DuPont analysis when comparing peers whose returns differ, to show whether a premium valuation rests on margins, efficiency or leverage; when assessing a turnaround or a buyout, where the plan usually targets margin and turnover; and in financial institutions, where leverage is part of the business and the decomposition is adapted to the structure of a bank's income statement, as in the financial institutions guide's article on DuPont decomposition for banks. In every case, the point is the same: return on equity is a product of three different stories, and the analysis is not finished until each one has been told.

The decomposition also connects to valuation. A company's price-to-book multiple equals its return on equity multiplied by its price-to-earnings multiple, so a high price-to-book ratio can reflect a high-margin business, a highly efficient one or simply a highly leveraged one. Knowing which helps judge whether a valuation premium is likely to last, and for a leveraged company, it points straight to the debt measures covered in leverage and coverage ratios.