How to calculate Return on Equity?

[steve fleming]

Dupont Formula isn't much in vogue but I think the Return on Equity version is easier to work with if expressed as:

(Net Income / Sales) * (Sales / Total Assets) * (Total Assets / Avg Equity)

So based on your numbers above (Sales I think are $5.562b) but adjusting out extraordinary movements in earnings (Earnings back down to $955m)...

=(955/5562) * (5562m/8176) * (8276/3604)
=0.1717 * 0.6803 * 2.296
=0.2681
=26.81%

Personally, I'd just go for ROE as Net Income / Avg Equity (or more simply End of Year Equity)...

Halebop,

The two formulae you quoted are exactly the same??

The sales & total assets being both a denominator & numerator simply cancel out?

In your example total assets are calculated as $8,176b and then $8,276b. What is the $100m adjustment?

Cheers

[Halebop]

Oops. The $100m was a typo in my spreadsheet transposed to post. Only excuse I can offer is that I was eating squid and typing with one hand.

Du Pont is not intended as a ROE measure, the last part of the equation turns it into an ROE measure but it gets you back to where you should be anyway If the user stuck with a simple ROE calc.

Du Pont is really a qualitative measure used to weed out low margin, high Capex businesses or identify high margin / low capex stars. I suspect without intending to DuPont also created a benchmarking tool because to my mind it is really most effective when measuring peers rather than a grab-bag of targets.

Du Pont alone (without trying to get back to ROE) is (Profit / Sales) * (Sales / net Assets). So I'm not sure if it tells you much of anything useful to compare a low margin / low asset supermaket with a high margin / high asset property company for instance. Particularly on a trending series, I think it is more useful to compare a basket of super market operators or a basket of property companies.

It's one measure though and I suspect not popular for some good reasons. Not least of which is you can't tell what you are seeing from the results - did Assets or Margins contribute most to the outcome? Buffett's simple tenets are much easier by keeping them on separate lines.