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Understanding the F40

How does the modified Dupont Model reward utilities?

Fortnightly Magazine - September 2007

neutrality of the Dupont Model to dividends is a somewhat surprising finding.

Share price is contemplated only in the model as it relates to dividend yield. Changing share price will affect dividend yield, since the model uses the formula annual dividends per share divided by year-end share price. However, market capitalization is not a considered factor.

Cash-flow statement metrics are captured through the use of both operating income and capital expenditures. Combined, these two metrics create free cash flow and are given significant weighting in the model, at 16.67 percent. Not surprising, companies are rewarded by the model for having positive free cash flow. The implication is that the model is punitive to companies with significant capital-expenditure requirements.

Balance-sheet impacts are captured through the use of total shareholder equity and total assets. However, shareholder equity is the least weighted of all factors in our analysis at 2.5 percent.

Total company assets are used in calculating three of the six key formulas: Sustainability, Dupont ROA, and Dupont ROE. In the Dupont ROA calculation, assets represent 25 percent of the formula. In the Dupont ROE calculation, assets represent less than 20 percent of the calculation. Overall, assets rank fourth in the impact on the Fortnightly 40 rankings, with a weighting of 9.17 percent.

So while the hybrid Dupont Model is very much tailored to asset-intensive industries such as energy utilities, it is not just a simplistic measure of asset efficiency. It captures key metrics from the income statement, cash-flow statement, and balance sheet, as well as the impact of the company’s common equity on its dividend policies. And it focuses on the fundamental aspect of all businesses, the creation of real profits.