Conclusion

The DuPont Model is a tool that is used in the operational filter. Its function in the operational filter is to understand the short-term impacts on value. In other settings the model had been used to diagnose changes in ROA and ROE. The ROA model looks at two drivers of financial performance—profit margin and asset turnover. We have adjusted the model for our purposes to align with the concept of intrinsic value. We have replaced the profit margin with cash flow in the profit margin calculation to integrate the concept of cash flow into the model. This new component, called the cash flow margin, measures how efficiently a business is being managed. The other driver in the equation, asset turnover, is a gauge of the ability of your assets to produce revenue.

ROE integrates the concept of leverage into the ROA model. Leverage is the relationship between debt and equity. This relationship has an impact on the adjustment for risk (the cost of capital) in the intrinsic value formula. We will discuss this relationship in Chapter 10. ROE is an indication of how much cash flow your equity or shareholder investment is producing.

The DuPont concept is used in the SWAV to pinpoint short-term swings in ROA based on changes that Strategic Alternatives will make on business drivers. The critical point is to understand whether these short-term swings may become permanent changes in the company. It also is a way of doing "what if" scenarios quickly. The DuPont Model is a diagnostic tool and does not measure intrinsic value. It is focused on the short-term trends as opposed to long-term value.