The most important ratio for shareholders is ROE or Return on equity. It measures how much return the company generates for shareholders. Out of these profits, the shareholders will get dividends and the balance will be ploughed back into the company which will help in growth. One of the most popular approaches to analyzing ROE is using the Du Pont approach. First used by Du Pont Inc of the US, this measure breaks up the ROE into components and identifies the key problem areas in the business. In fact, the Du Point Analysis (ROE Analysis) is a very important starting point for company analysis.
ROE = This equation can be further broken up as the product of 3 equations as under:
ROE = xx
? ROE = Net Profit Margin X Asset Turnover X Total Leverage
The Return on Equity (ROE) is a product of the net profit margin, asset turnover, and total leverage. When you break up the ROE using Du Pont Analysis, you can pinpoint the precise reason why the ROE is falling or rising.