Using Industry-Adjusted Dupont Analysis to Predict Future Profitability

48 Pages Posted: 26 Oct 2003

See all articles by Mark T. Soliman

Mark T. Soliman

University of Southern California - Marshall School of Business

Date Written: February 2004

Abstract

Industry peer groups serve as both a theoretical and an intuitive benchmark in financial statement analysis. However, the practice of industry-adjusting financial ratios is sparse in existing financial statement analysis research. Much of the academic research on the mean reversion of profitability assumes economy-wide reversion targets. Economic theory supports the use of this target and empirical evidence is consistent with these predictions. However, some components of profitability may not revert to economy-wide averages because of structural differences across industries. For these components, industry averages serve as better long-term targets. DuPont analysis decomposes return-on-net-operating assets (RNOA) into two multiplicative components: profit margin and asset turnover, both of which are largely driven by industry membership. This paper investigates whether using industry-adjusted DuPont analysis is a useful tool in predicting future changes in RNOA. In contrast to prior research that used economy-wide targets and finds that these components are not useful in forecasting, I find that these components are informative when industry-adjusted and that using them helps predict future changes in RNOA in both in-sample and out-of-sample forecasting tests.

Keywords: Industry Adjustment, Financial Statement Analysis, DuPont Analysis

JEL Classification: M41, L16

Suggested Citation

Soliman, Mark T., Using Industry-Adjusted Dupont Analysis to Predict Future Profitability (February 2004). Available at SSRN: https://ssrn.com/abstract=456700 or http://dx.doi.org/10.2139/ssrn.456700

Mark T. Soliman (Contact Author)

University of Southern California - Marshall School of Business ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
6,783
Abstract Views
22,721
rank
880
PlumX Metrics