- In the area of financial ratios, the DuPont framework
might be the most well known ration there is.
Now let's look at a real company.
Let's look Ford Motor Company,
and then we're going to compare Ford and General Motors.
In 2018, Ford's return on equity was 10.2%,
again, that was in the good range, barely,
but now, let's compare their 2018 performance
to their 2017 performance.
We see in 2017 their return on equity was 21.7%.
Now, what's the obvious question?
Why?
Why did it drop from 21.7% down to 10.2%?
Well, we can start to answer that question
by using the DuPont framework.
As you can see here, we have the DuPont framework
for 2018 and 2017.
We've got Ford's performance broken by profitability,
efficiency, and leverage.
Let's just take a look at these comparisons
and see what we can conclude.
First of all, let's look at leverage.
In 2017, their leverage was 7.26.
In other words, they had $7.26 in assets
for every dollar's worth of equity.
In 2018, that dropped a little down to 7.13,
but that drop accounted for very little
of the big decline in the return on equity.
So, leverage, that's not the issue.
When it comes to efficiency,
we see that between 2017 and 2018,
Ford actually got a little more efficient
at generating sales with its assets
from .61 up to .63 in 2018.
So, we know the reason for decline
was not because they were less efficient
with using their assets,
they were, in fact, a little more efficient.
Now, when we look at the third ratio,
the third component of return on equity, profitability,
we see that that is where Ford got hit.
In 2017, their return on sales was 4.9%.
In 2018, it was 2.3%.
Was the issue leverage?
Ah, a little bit.
Efficiency?
Not at all.
Profitability?
From 4.9% down to 2.3%, that's a significant difference.
So, what can we conclude from our DuPont analysis
comparing 2017 and 2018?
What we conclude is that over time,
Ford had a little less leverage,
they were a little more efficient,
and they were a lot less profitable.
This one item resulted in their return on equity dropping
by half from 21.7% down to 10.2%.
So, what would be the next step?
Well, we need to drill down into the income statement
and see what items on the income statements
cost the steep decline in profits.
Now, just to make it interesting,
let's compare Ford in 2018 with General Motors in 2018.
You can see that General Motors' return on equity
in 2018 was 18.5%.
That's a lot higher than Ford's 10.2%.
Now to the obvious question, why the difference?
What was General Motors doing so much better than Ford
in 2018?
Well, again, we can break down return on equity
into its three components, profitability, efficiency,
and leverage.
We know that Ford actually has more leverage
than General Motors does.
7.13 compared to 5.31.
That would cost Ford's ROE to be higher.
So, leverage is not the reason for GM's higher ROE.
Now we turn our attention to efficiency.
We see that GM is slightly more efficient than Ford,
but that small difference does not account
for the big difference in ROE.
So, the big difference in ROE
between the two companies wasn't leverage,
Ford actually had the advantage there,
and it wasn't efficiency.
It has to be profitability, it has to be.
And, no surprise,
we see that General Motors was just a lot more profitable
in 2018 than was Ford.
More than twice as profitable
as measured by the profit margin ratio.