I wanted to write a thread on DuPont - but in a way that actually made the concept interesting in relatable.
So instead of doing a basic theory thread, I thought I'd explain it using NIFTY500 firms as examples!
Please do RT if this thread made your Sunday a teensy bit better!♻️
So instead of doing a basic theory thread, I thought I'd explain it using NIFTY500 firms as examples!
Please do RT if this thread made your Sunday a teensy bit better!♻️
What a DuPont analysis attempts to do is breakdown Return on Equity into its constituent parts to se what is driving the RoE!🥧
There are two variants of the DuPont, a three part and a five part - but you'll likely never see the five part anywhere outside the CFA curriculum, so we'll focus on the three part for now. 🤷♂️
Put simply, DuPont divides the RoE formula into three part
Net Income / Shareholder's Equity =
(Net Income/ Revenue)*
(Revenue/Total Assets)*
(Total Assets/Shareholder Equity)
Net Income / Shareholder's Equity =
(Net Income/ Revenue)*
(Revenue/Total Assets)*
(Total Assets/Shareholder Equity)
The three terms being multiplied are net margin, asset turnover and equity multiplier respectively.
Before we look at this with examples, let us understand this intuitively. If you want to maximize the return you generate on your equity, there are three ways to do it
1. Sell premium: Earn a high net margin on every unit you sell
2. Sweat your assets: Increase utilization of your factories and machineries to produce and sell high volumes
3. Stress your balance sheet: Borrow to build a higher asset base, and earn on that higher asset base
2. Sweat your assets: Increase utilization of your factories and machineries to produce and sell high volumes
3. Stress your balance sheet: Borrow to build a higher asset base, and earn on that higher asset base
When a person typically starts their investing journey- they love 1, are indifferent of 2, and detest 3.
A high net margin is easily visible and quoted by most websites. Asset turns are relatively undercovered and under-appreciated. And leverage is typically hated on.
A high net margin is easily visible and quoted by most websites. Asset turns are relatively undercovered and under-appreciated. And leverage is typically hated on.
But great businesses using all three levers. So today we'll use real life companies as examples of how the three levers can be managed.
We looked at the NIFTY500 universe, and eliminated companies that generated below 25% RoEs - reaching a list of 76 firms. Within this we sorted by profit margin, asset turns, and equity multiplier to see how the firms performed.
Profit Margin Prodigies
The top quartile business have 30%+ net margins generally operating off a low cost base -
eg: HDFC AMC, IEX, Naukri, AB AMC, ISec, CAMS... you get the gist
The top quartile business have 30%+ net margins generally operating off a low cost base -
eg: HDFC AMC, IEX, Naukri, AB AMC, ISec, CAMS... you get the gist
It is important to note the sort of businesses that can can sustain these sorts of margins have a reasonably strong moat - network effects, regulatory barriers, distribution channels - something that hinders folks from coming in and competing the margin away.
It is very difficult to have a consumer staples company or a retail chain to sustain these sorts of margin, because you'll have a player come in and compete the margins away.
So how does a DMart which is a discount retailer, or a Hatsun Agro which is milk product company generate good RoE when the ability to have high margins is limited?
They play on the second lever - Asset turns.
They play on the second lever - Asset turns.
Asset turn players use scale and efficiency to build a virtuous cycle for them. Plant and inventory efficiency get costs down, low costs get more people through the door, scale improves plant utilization and inventory turns... you get the gist
This is an often misunderstood lever - but is a tremendously sustainable lever for generating RoE. As you can imagine - with every year your business scales more and becomes more efficient - making it awfully hard for folks to sustainably compete with you.
Which brings us to the last lever - Equity multiplier. This is typically the last lever people want to see firms using - because the debt adds a risk to your business - especially when the going gets tough.
But here too there are exceptions - firms like Muthoot or Mannapuram, who have 4x+ equity multipliers, but the business mitigates risk because they're giving out secured gold backed loans.
There are also businesses like Indus Towers who have good visibility of the future revenues and therefore can afford higher leverage in the business.
And then there are the kids in school who will do reasonably well in acads, play on the school team, and also find a spot in the dramatics club. Firms that don't ace margins, turns, or leverage but do all well enough to generate a good return.
Page, Marico, Britannia, CGCEL, Galaxy Surf all manage to get to healthy RoEs by having net margins in the 10-20% asset turns in the 1-2x and equity multipliers in the 1-2x range.
Hopefully this thread helped you understand both DuPont and RoE better with real life context.
As Mr Bikhchandani puts it "Bhagwan ek hai, bhagwan tak ke raste anek."
Know your company's rasta!🛣️
Know your company's rasta!🛣️
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