This week, we’ve looked at the effect of leverage on the returns of various companies.
Tonight, I would like you to have some fun with the Dupont model, which is an interesting way to deconstruct Return on Equity into its component parts.
This was a heavily tested area of the CFA exams.
Here’s what to do:
Pick an industry.
Pick four public companies in that industry.
Pull the income statement and balance sheet data for each of these companies for at least three periods.
Prepare a DuPont analysis in which you calculate and assess each company’s:
- Tax Burden is (Net income ÷ Pretax profit). This is the proportion of the company’s profits retained after paying income taxes.
- Interest Burden is (Pretax income ÷ EBIT). This will be 1.00 for a firm with no debt or financial leverage.
- Operating Margin is (EBIT ÷ Sales). This is the operating income per dollar of sales.
- Asset Turnover (ATO) is (Sales ÷ Assets).
- Financial Leverage ratio is (Assets ÷ Equity), which is equal to the firm’s [[debt to equity ratio]+1] . This is a measure of financial leverage.
In addition, I’m curious to know how leverage is connected to the P/E multiple, so please show how their P/E multiples have changed for each company and reporting period.
Show your work and summarize your findings in any way you feel is appropriate.