A study of Profit Margin, Asset Turnover and Its impact on Strategy using Du Pont Model

There are three things which affect ROE-Operating efficiency, which is measured by profit margin?-Asset use efficiency, which is measured by total asset turnover-Financial leverage, which is measured by the equity multiplier. ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity).

This system of analysis considers important interrelationships between different elements of financial statements. Most of the time investors do not prefer to highly profitable companies. They investigate the DuPont equation. Through DuPont analysis they see which types of companies are most fruitful for investor. They use two method of ranking, first one is base on profit (Net income) and second one is base on DuPont equation.

This paper shows Firms having high profit margin but low asset turnover accept differentiation strategy, firms however, having low profit margin but high asset turnover go with cost leadership strategy.

The result shows Companies under category of Differentiation Strategy outperform those companies under category of Cost Leadership Strategy. Performance is measured by RONOA and RONOA of companies under category of Differentiation Strategy are always greater than those companies under category of Cost Leadership Strategy.

The result shows that the ranking according to DuPont method are more reliable for investors as compare to profit (net income). The study demonstrated that in terms of price per share, the investors are not directly influenced by the return on equity of analyzed companies but the components of Du Pont analysis attract them (investors) towards theses companies. Du Pont components represent an important and viable form of stock's abnormal returns analysis which supports market participants in making their investment decisions. The importance of Asset Turnover ratio has been drawn from this research paper while comparing the efficiency and return on equity between two companies. The integration of income statement and balance sheet gives better indication or views regarding company's financial health. Du Pont chart helps to control company's various activities. There is comparison between standard ratio and present ratio and changes in performance are derived. How performance can be improved and control can be exercised using Du Pont Model is explained in this paper.