The core idea
Financial statements give you thousands of numbers. Ratio analysis reduces them to a handful that tell a story. DuPont decomposes ROE into margin, turnover and leverage. EVA asks whether the return exceeded the cost of capital. Together they are the bridge from accounting to investing. — after Stern & Stewart
The hero diagram
The five ratio families.
Every question about a business lands in one of these five.
The rules on the page
The rules of the game.
DuPont Decomposition · DuPont
ROE = Net margin × Asset turnover × Equity multiplier · (Equity multiplier = Assets / Equity)
Three levers for ROE. Most firms overuse one and underuse two.
Liquidity Ratios · Working capital
Current · Quick · Cash
Can the firm survive the next 90 days?
Solvency Ratios · Leverage
Debt/Equity · Debt/Assets · Interest coverage
Can the firm survive a downturn?
Efficiency Ratios · Asset utilisation
Asset turnover · Receivables days · Inventory turnover
How much revenue per pound of asset?
ROIC vs WACC · Value creation
ROIC = NOPAT / invested capital · EVA = (ROIC − WACC) × IC
Value is created only when ROIC exceeds WACC.
How to apply
One-page analysis of any company.
- Run DuPont. Decompose ROE into margin, turnover, leverage.
- Compare to peers. Ratios are meaningless in isolation. Benchmark.
- Ask: does ROIC exceed WACC? If yes, value is being created. If no, capital is being destroyed.
- Trend the last five years. Direction matters more than the single-year reading.
Key reading · Session 10 · Kraft
Performance measurement and financial analysis.
Knowing the ratios is easy. Knowing which ratio matters for which industry, and what the peer benchmark actually is, is the difference between a course answer and a useful analysis.
The number only means something next to another number.