3.3 DuPont Pyramid
An ROE is gonna show me which company is the better performer, right? But then I like to do the DuPont Pyramid and go into it and see what is driving up the ROE on a company and what might be bringing it down. So it's just a great way to get into the analytics of a company, or a set of companies and get some more information quick and dirty, but very relevant information that we can use, that's the DuPont Pyramid.
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Okay, so the DuPont Pyramid. What is the DuPont Pyramid? The DuPont Pyramid looks at ROE. Remember, I told you, the big boy of the ratios. Return on equity. And using a couple mathematical formulas, what we do is we take ROE and we divide it into three sub formulas that give us even a better understanding of how that business is doing. So we can calculate a business’s ROE, right. And then we can compare that to other businesses. But then we can go a little bit deeper. And basically we’ve got three formulas in the DuPont Pyramid. We’ve got one which is the profit margin formula. Profit divided by sales. This is gonna show us operating efficiency. How efficient is the business running? How much, how efficient is it producing it’s profit? The next one is asset use efficiency, and that’s the total asset turnover. Which is sales or revenues divided by assets and that’s going to show us how efficiently the business is utilizing the assets that it has, okay. And the last one is financial leverage financial leverage or the equity multiplier is assets divided by equity. And this is gonna tell us how financially leveraged the business is. Now again, I’m not gonna go into the mathematics of this but if you look at the original ROE equation, then you realize that these equations are all embedded into it. So personally, when I’m evaluating companies in the sector what I like to do is I like to choose the companies I want to evaluate, and I really quickly run ROE on those companies. An ROE is gonna show me which company is the better performer, right? Over all, of all of these. But then I like to do the DuPont Pyramid and go into it and see what is driving up the ROE on a company and what might be bringing it down. So it’s just a great way to get into the analytics of a company, or a set of companies and get some more information quick and dirty, but very relevant information that we can use, that’s the DuPont Pyramid.
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