Using the Du Pont Identity
– Profit margin is a measure of the firm’s operating efficiency – how well does it control costs – Total asset turnover is a measure of the firm’s asset use efficiency – how well does it manage its assets – Equity multiplier is a measure of the firm’s financial leverage
• Finally, the financial leverage ratio used above does not recongnize the fact that a firm's cash and short-term investments are in essence "negative debt(资本)" because they can be used to pay down the debt on the company's balance sheet. • These issues are addressed by an alternative approach to decomposing ROE. • that is ROE=Operating ROA+Spread • *Net financial leverage
the Du Pont Identity
• An expression that breaks ROE down into three parts : Profit margin,Total asset turnover and Financial leverage(equity multiplier). it is also known as "Dupont Analysis". • The method is first used by a firm named Dupont which is a large chemical company.
Determinants of Growth
• Profit margin – operating efficiency • Total asset turnover – asset use efficiency • Financial leverage – choice of optimal debt ratio • Dividend policy – choice of how much to pay to shareholders versus reinvesting in the firm
Table 3.6
Sustainable growth rate
• Suatainable growth rate is the rate at which a firm can grow while keeping its profitability and financial policies unchanged. • A firm's return on equity and its dividend payout policy determine the pool of funds avaliable for growth. • Of course the firm can grow at a rate different from its sustainable growth rate if its profitability, payout policy,or financial leverage changes. • Therefore,the sustainable growth rate provides a benchmark against which a firm's growth plans can be evaluated.
Retained ratio (Plowback ratio)used to measure the current in the total net income what is the percentage retained in the enterprise for development, it embodies(体现) the enterprise management policies.
Payout and Retention Ratios
• Retention ratio = Additions to retained earnings / Net income = 1 – payout ratio
1.31 / 2.17 = 0.6037 = 60.37% Or 1 - 0.3963 =0 .6037 = 60.37%
Two parts:
1.The Du Pont Identity
ing Financial Statement Information
What is ROE?
• The starting point for a systematic analysis of a firm's performance is its return on equity(ROE). • defined as ROE=Net income/ Total equity • ROE is a comprehensive indicator of a firm's performance because it provides an indication of how well managers are employing the funds invested by the firm's shareholders to generate returns.
• Further,net income includes income from operating activities as well as interest income and expenses, which are consequences of fianancing decisions. Often it is useful to distinguish between these two drivers of performance.
ROE = (NI / TA) (TA / TE) (Sales / Sales) ROE = (NI / Sales) (Sales / TA) (TA / TE) ROE = PM * TAT * EM
the Du Pont Identity
• ROE = ROA*EM • =PM * TAT * EM • =Profit margin • * Total asset turnover • * Equity multiplier • =Net income/ Sales • * Sales/ Total assets • * Total assets/ Total equity
the Du Pont Identity
• Dupont Analysis is to analysis enterprise's financial position by using the relationship between several financial ratios. • Its basic idea is to divide ROE into a number of financial ratios' product, which is help to further analysis the enterprise's business performance.
Payout and Retention R dividends / Net income
0.86 / 2.17 = 0.3963 or 39.63%
A firm's dividends payout ratio is a measure of its dividend policy. Firms pay dividends for several reasons. They provide a way to return to shareholders any cash generated in excess of the firm's operating and investment needs.
Payout and Retention Ratios
• When there are information asymmetries (不对称) between a firm's managers and its shareholders, dividend payments can serve as a single to shareholders about managers' expectation of the firm's future prospects. Firms may also pay dividends to attract a certain type of shareholder base.
Deriving the Du Pont Identity
• ROE = NI / TE • Multiply by 1 and then rearrange
ROE = (NI / TE) (TA / TA) ROE = (NI / TA) (TA / TE) = ROA * EM
• Multiply by 1 again and then rearrange
• Even though the above approach is popular used to decompose(分解) a firm's ROE,it has several limitations. • In the computation of ROA,the denominator(分母) includes the assets claimed by all providers of capital to the firm,but the numerator（分子）includes only the earnings avaliable to equity holders.The assets themselves includes both operating assets and financial assets such as cash and short-term investments.