Harbor Coffee, our fictional coffee business, has a 28.33% return on equity. Before calling it a strong business, you need to know what produced that number.
For FY3, does it keep more profit from sales, get more sales from its assets, or use a smaller slice of owners' equity?
DuPont analysis splits ROE into those three parts. You can trace each one back to the same accounts, then decide what deserves a closer look.
Put four inputs on one page
Harbor's FY3 accounts report revenue of $1,100 million and net income of $150 million. Use millions of dollars in the calculations below.
Use the same opening-and-closing averages as before:
- Average assets: (968.4 + 1,000.4) ÷ 2 = $984.4.
- Average equity: (514.4 + 544.4) ÷ 2 = $529.4.
Harbor's net income and equity both belong to common shareholders.
The three-part identity connects these inputs:
These are factors to multiply, not scores to add. For Harbor, the product must equal 150 ÷ 529.4, or 28.33%.
First, follow the margin
Harbor's net profit margin is 150 ÷ 1,100, or 13.64%. It keeps about 13.64 cents of net profit from each sales dollar.
Harbor's operating profit is $220 million. Subtract $20 million of interest and $50 million of tax, and you have the $150 million that belongs in this calculation. Using operating profit would skip those costs and overstate ROE.
A smaller interest or tax bill can lift net margin without changing how Harbor makes or sells coffee. A better net margin does not always mean better operations.
Next, follow the assets
Total asset turnover is annual revenue divided by average total assets. For Harbor, 1,100 ÷ 984.4 gives 1.1174×: about $1.12 of annual sales for each $1 of recorded assets.
The asset base includes cash, inventory, equipment and goodwill. This turnover measures sales relative to all those assets; it is neither inventory turnover nor share-trading volume.
More sales per asset dollar can make a thin margin work. Suppose one business keeps 10% of sales as profit and generates $1 of annual sales per $1 of average assets. Another keeps 5% but generates $2 of sales per asset dollar.
Both earn 10 cents per asset dollar: a 10% return on assets. Margin multiplied by turnover gives ROA. With the same equity multiplier, they also have the same ROE.
Then, follow the financing
The equity multiplier is average total assets divided by average equity. Harbor's is 984.4 ÷ 529.4, or 1.8595×.
For every $100 of average equity, Harbor has about $185.95 of average assets. The other $85.95 is supported by liabilities. A bigger multiplier means more assets sit on each dollar of equity.
Trade payables, the bills owed to suppliers, count alongside borrowings. That is why the multiplier is not a debt-to-equity ratio. The debt and leverage checks help you assess the funding behind it.
Multiplying the unrounded factors closes the chain:
The repeated revenue and average-asset figures cancel, leaving net income divided by average equity. Using closing assets in one step and average assets in another would break the chain.
The factors can move together. If a business borrows cash and leaves it idle, the extra assets lift the multiplier but lower turnover. Those effects cancel in the product; interest expense can still drag on the margin. A bigger multiplier is not a free boost to ROE.
For Harbor, the first step is to compare each factor across FY1–FY3, then with similar businesses. Harbor's FY3 figures alone cannot tell you which factor is unusually strong. Ratios show what happened, not why.
A margin change calls for a look at prices and expenses. For turnover, compare sales growth with changes in the asset base. For the multiplier, check liabilities relative to equity. The decomposition points to the part of the business that needs explaining.
The same ROE can hide two engines
Suppose two businesses have these figures for one year:
| Factor | Profile A | Profile B |
|---|---|---|
| Net margin | 10% | 5% |
| Asset turnover | 1.0× | 1.0× |
| Equity multiplier | 2.0× | 4.0× |
| ROE | 20% | 20% |
A earns 10% × 1.0 × 2.0 = 20%; B earns 5% × 1.0 × 4.0 = 20%. Which needs a closer look at its funding?
B. Half the margin and twice the multiplier produce the same headline ROE.
Using average balances, each $100 of equity supports $200 of assets and $100 of liabilities in A. In B, it supports $400 of assets and $300 of liabilities. Both earn $20.
The equal return hides B's heavier reliance on liabilities. It gives you a reason to inspect B's funding, not a reason to declare A the better investment.
Whether competitors can take those returns away is the question behind economic moats.
In short
- ROE is net margin × total asset turnover × the equity multiplier.
- Use the same year's accounts, average balances and income and equity tied to the same owners.
- The equity multiplier reflects all liabilities, including supplier bills.
- Equal ROE can hide a thin margin backed by much more leverage.
- Compare the factors with history and peers; the arithmetic alone cannot prove the cause.