The DuPont decomposition allows us to identify a firm’s performance drivers, allowing us to expose effects of weaker areas of business that are being masked by the effects of other, stronger areas. For example, a firm could offset a declining EBIT margin by increasing asset turnover or increasing leverage.
ROE = Tax Burden x Interest Burden x EBIT Margin x Total Asset Turnover x Financial Leverage
We must also consider the firm’s sources of income and whether the income is generated internally from operations or externally. For example, the firm has less control over income that is generated by an ownership interest in an associate than over income generated internally. If equity income from associates or joint ventures is a significant source of earnings, we should isolate these effects by removing the equity income from our DuPont analysis to eliminate any bias.