5 step DuPont Equation

As show in this article, we can dissect the ROE with a 3 step DuPont Equation

• ROE = Net Income/Equity 
• = Net Income/Sales * Sales/Total Assets * Total Assets / Equity -
  The sales and total asset on the right side of the equation negate each other, seeing as one is in the numerator and one is in the denominator
• = Net Income Margin * Asset Turn Over * Financial Leverage

With the three step model, you see whether a company is boosting ROE through improved profitability, asset turnover or financial leverage. While a 5 step DuPont Equation, break down the Net Income Margin to show you how tax and interest affect ROE.

•  ROE = Net Income/Equity
• = Net Income/Pretax Income * Pretax Income/EBIT * EBIT/Sales * Sales/Total Assets * Total Assets/ Equity
• = Tax Burden * Interest Burden * Operating Margin * Asset Turnover * Equity Multiplier 
• Tax burden is the proportion of profits retained after paying taxes
• Interest burden shows how interest is affecting profits. If a company has no debt, the ratio will be 1. 
• Operating income margin is the operating income per dollar of sales 
• Asset turnover shows asset utilization efficiency
• Equity multiplier shows financial leverage

References:-

• 5 Step DuPont Analysis - Jae Jun

DuPont Analysis - MAGNI vs PRLEXUS

Table 1 and Table 2 show how the Latest 10 Years ROE of MAGNI and PRLEXUS were achieved based on DuPont Analysis respectively.

Year	2013	2012	2011	2010	2009	2008	2007	2006	2005	2004
Net Profit Margin	6.3%	5.7%	3.9%	4.4%	3.0%	3.0%	2.1%	1.3%	1.1%	2.9%
Sales Turnover	2.08	2.22	2.10	1.95	2.17	1.97	1.20	0.95	0.94	0.84
Financial Leverage	1.31	1.29	1.35	1.31	1.32	1.34	1.37	1.19	1.20	1.29
ROE	17.3%	16.4%	11.0%	11.2%	8.5%	7.9%	3.6%	1.4%	1.3%	3.1%

Table 1: ROE for MAGNI

Year	2013	2012	2011	2010	2009	2008	2007	2006	2005	2004
Net Profit Margin	7.3%	5.4%	2.5%	2.5%	0.2%	-1.8%	-3.2%	-2.0%	-2.6%	-3.5%
Sales Turnover	2.05	2.09	1.93	1.59	2.01	2.13	1.90	1.68	1.65	1.40
Financial Leverage	1.42	1.40	1.79	1.78	2.13	2.31	2.59	2.40	2.25	2.24
ROE	21.1%	15.9%	8.6%	7.0%	0.8%	-8.8%	-15.9%	-7.9%	-9.6%	-11.1%

Table 2: ROE for PRLEXUS

It is clear from the table above that PRLEXUS has achieved a much higher ROE of 21.1% compared to that of MAGNI of 17.3%. The higher ROE of PRLEXUS was achieved with a relatively high income margin of 7.3% compare to MAGNI – 6.3% and higher financial leverage (1.42 vs 1.31). Both companies have a similar sales turnover of 2.0.

Figure 1: Trends of ROE of MAGNI and PRLEXUS

Based on the last 10 years results, the ROE for MAGNI is growing from 3.1% to 17.3% (CAGR 21%) while PRLEXUS’s ROE was in negative zone on the first five year (2004-2008) and experience a very high growth on the next 5 years - 2009 to 2013 (0.8% - 21.1%).  

The growing of MAGNI’s ROE was achieved with growing Net Profit Margin and Sales turn over while the financial leverage is maintained. This show that MAGNI is not only improving its earning quality but in the same time produce more product with the asset.

While, PRLEXUS’s able to increase its ROE by increasing the Net Profit Margin and Sales turn over; and in the same time reducing the financial leverage. PRLEXUS net profit margin is turning from red to green on year 2009 and overtake MAGNI on year 2013.

MAGNI is a debt free company and it can increase the financial leverage and improves its ROE. However, financial leverage is a double edge sword it can hurt ROE badly in the bad times. And, high leverage can make a company’s balance sheet unhealthy and become risky during economy downturn.

From the above analysis, we can conclude that both companies is able to create value for its shareholder and PRLEXUS latest financial year ROE is much better than MAGNI. However, MAGNI presented a positive (and it is growing) ROE and net profit margin on the pass 10 years but PRLEXUS only turn to green 5 years ago. Furthermore, MAGNI is a debt free company and it can further increase the ROE by using financial leverage. In my own opinion, MAGNI provide a lower risk investment option if compare to PRLEXUS.