How does the DuPont decomposition of ROE work? I need both 3-factor and 5-factor versions.

DuPont analysis breaks ROE into its fundamental drivers, revealing why a company has high or low ROE. This is one of the most frequently tested topics on CFA Level I.

3-Factor DuPont:

ROE = Net Profit Margin x Asset Turnover x Financial Leverage

ROE = (Net Income/Revenue) x (Revenue/Total Assets) x (Total Assets/Equity)

What each factor reveals:

1. Net Profit Margin — How much profit the company keeps per dollar of revenue (profitability)
2. Asset Turnover — How efficiently assets generate revenue (efficiency)
3. Financial Leverage — How much debt amplifies equity returns (leverage)

Example:

Compare two companies with identical 15% ROE:

Luxora achieves ROE through high margins (luxury goods), while Volantis relies on high turnover (retail/grocery). Same ROE, completely different business models.

5-Factor DuPont (Extended):

ROE = Tax Burden x Interest Burden x EBIT Margin x Asset Turnover x Financial Leverage

ROE = (NI/EBT) x (EBT/EBIT) x (EBIT/Revenue) x (Revenue/Assets) x (Assets/Equity)

The 5-factor version adds:

1. Tax Burden (NI/EBT) — How much profit survives taxation
2. Interest Burden (EBT/EBIT) — How much operating income survives interest payments

This is useful when comparing companies across countries (different tax rates) or with different capital structures (different interest expenses).

Exam application:

• If ROE declined, identify which factor caused it
• Compare companies to understand differing strategies
• Use the 5-factor to isolate tax and interest effects

Exam tip: The exam will often give you two years of financial data and ask which DuPont factor most explains the change in ROE. Compute each factor for both years and compare.

Master financial statement analysis in our CFA Level I course.