If ROE is unsatisfactory, the Du Pont identity helps locate the part of the business that is underperforming.
Here is how the DuPont identity is derived:
ROE = NI/TE
Multiply by 1 (TA/TA) and then rearrange
ROE = (NI / TE) (TA / TA)
ROE = (NI / TA) (TA / TE) = ROA * EM
Multiply by 1(S/S) and then rearrange
ROE = (NI / TA) (TA / TE) (S/S)
ROE = (NI / S) (S / TA) (TA / TE)
ROE = PM * TAT * EM
ROE = Profit Margin * Total Asset Turnover * Equity Multiplier
When:
ROE = Return on Equity
NI = Net Income
TE = Total Equity
TA = Assets
ROA = Return on Assets
EM = TA/TE = 1 + D/E = The Equity Multiplier
S = Sales