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IFB84: Dupont Analysis Lesson from the CFA Level I Test

Return on Equity is a quick and easy way to discover how well a company turns its assets into equity. The Dupont analysis goes even further into discovering how the company grows its return on equity. Be it through leveraging debt or growing revenue.

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern to decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:35                     All right, folks, we’ll walk up to testing for beginning podcast. This is episode eighty-four tonight. Andrew and I are going to do a two-parter here. So what we’re gonna do is we’re going to talk about the Dupont analysis and the reason why we’re going to talk about this is we got a great question from Facebook that Andrew and I wanted to answer on air, but we wanted to talk you guys through what the Dupont analysis was so that when we answered the question and it kind of makes sense to you guys. So for those of you who are not familiar with Dupont analysis, all raise your hand. Okay? That’s everybody. All right, so this is something that is not talked about a lot and it’s a very interesting analysis and what it is in a nutshell is the breakdown of the return on equity. And Andrew, I’m going to have you talk a little bit about return on equity and then we can kind of talk a little bit about how this analysis kind of that.

dupont analysis

Andrew:                              01:31                     Yeah, sure. If you’re the asked me that question yesterday, I would’ve had my hand up to. So definitely not aware of it. I’m definitely aware of the return on equity. So that obviously helps a lot. We’ve turned. Oh, we’ve talked about return on equity before we had an episode in the archives or we talked about some of the efficiency ratios, return on assets, return on equity, so that episode might be a good supplement to this one and maybe if you listen to those back to back get a better understanding. I know it’s not that easy to learn these kinds of advanced topics through a podcast, but I think the more exposure you get to it, whether that’s through a podcast or through reading or just writing out some exercises, is trying to do them with some companies and stocks are out there. Then the more and more you can learn and kind of digest it.

Andrew:                              02:20                     Like you said, Dave, Dupont analysis is a breakdown of the return on the equity and it essentially breaks it down into three parts. So why it’s called Dupont is because, um, there’s a, there’s a meeting, it’s not, it’s still public, it’s called Dupont, now it merged with Dow Chemicals and now it’s called Dow Dupont. But there were three gentlemen there and they came up, basically, they wanted to figure out how, how they kind of take the return on equity and take it to the next step. Um, so if you have, for example, if you have a company with a lower return on equity, you can break the return on equity down to these three pieces. And so if, if, if you see that your company’s return on equity is lagging compared to its competitors, breaking it down in this way can help you kind of identify where is the pain point, why is it lagging and how can we attack it?

Andrew:                              03:17                     We’ll get a little bit deeper into that. I like it because it was actually an electrical engineer who first kinda came up with the idea and then these three guys from Dupont back in the 19 twenties ended up kind of making it popular. And now it’s, I’m like, you’ll hear in the question from the sky on Facebook. It’s part of the CFA level one course. So, um, CFA, I think it stands for what? Chartered financial analyst. Yes. Basically, I see the CFA is like the MBA of the business world. Um, some circles require it. If they’re going to hire you, some circles really look at it really highly and other circles don’t care. And there are lots of businessmen who are successful who don’t have an MBA. I think the CFA is very similar to that, but that’s kind of a background of Dupont and why we’re going to talk about it and why it can be helpful and useful.

Andrew:                              04:14                     And that’s. So that’s why they break it down into these three parts. And so I think we should talk about each of these three parts separately and try to give you some insight on it. So return on equity. You can break it up into, into three pieces. The way you can do this, I’ll, I’ll explain this with a simple math problem because it is a math problem. Um, return on equities. Obviously, net income divided by shareholder’s equity. We’re just trying to see how much profits you make from the equity you have, which is the same as the book value. It’s the difference between your assets and your liabilities. Um, if you think about a math problem where you have two fractions, let’s say you have one over to right, and you multiply it by, let’s say two over three. You have the two on the denominator and the two and the numerator and those two cancel out.

Andrew:                              05:07                     And so that’s really what’s happening when we’re breaking down the Dupont analysis into these three parts with return on equity. Uh, there are three financial metrics. When you do the multiple locations, they will kind of cancel each other out. So that’s how you’ll get the net income divided by the shareholders’ equity. But breaking it out in this way again helps us kind of be more specific on, on what’s going on with a particular business. So the first part of the return on equity is the return on sales and that is simply the net income divided by the revenue. So that first components return on sales. Basically, the equation for that is net income divided by revenue. What you’re trying to find is basically how efficient a business plan is. So what, you know when you have the revenue, that’s the top line, this is how much money you’re bringing in and then it’s going to cost money too, to bring that revenue in, right?

Andrew:                              06:13                     So let’s say we’re selling the cool widget, it’s going to cost us like 20 bucks to manufacturer that widget. We brought in 30 bucks. So we have $20 for expenses, maybe we have some more expenses we have to pay. Um, you know, obviously we have to pay taxes, we have to pay for our employees, blah, blah, blah, blah. You go down the line and from that revenue sprinkles all the way down and you have that income at the bottom profit. So when you combine those to a higher return on sales is basically you can think of, they talk about it like margin, gross margin, net margin, profit margin. I’m sure you’ve heard if you can, if you can’t tell, like when you, when you start getting into financial statements, there’s a lot of terms that mean the same thing. Two different terms that mean the same thing.

Andrew:                              07:07                     I think that makes things really confusing for people. That’s why a lot of times I tried to say, you know, book value or shareholders’ equity. Hopefully, just through repetition, you can start to understand these things and I kind of processing them. But you know, when we’re talking about margins, gross margin, that margin return on sales, what you’re basically figuring out is what kind of products does this company sell and how profitable are those products? Do you think about something like a? An easy example would be an oil rig. Obviously, I’m like an Exxon mobile. It’s going to cost them a lot of money. The drill that oil out of the ground and so they’re going to need a bringing a ton of sales. And our other to come up with enough money to pay those expenses and um, have a profit at the end of that. And then on the flip side, if you think of a co, a business like Facebook where, um, you know, they, they just have to maintain a website, maybe they have some computer engineers, some, some computer science coders that they need to pay to maintain the website, um, but they can have a lot of profit and they don’t need to invest in expensive equipment.

Andrew:                              08:24                     And so their return on sales can be much, much higher. This is something that because of that definition and how I said it, it can really depend on what industry it is. And so just because you see a business that has a higher return on sales, then another business, it doesn’t necessarily mean that’s better, but when you compare like inside of an industry, you can see which companies in that industry or maybe doing a better job of being more efficient, uh, making that revenue and turning it into profit. So you can maybe pick up on companies that are really good. I, I keep expenses low a or if they’re able to be profitable in other ways. It’s a nice thing. I think it gives some context. I don’t think it’s, it’s an end all be all and that’s really true for the return on equity ratio as well. But when it comes to return on sales, that’s kind of something that you can glean out of that. And um, I look at and so if you have.

Andrew:                              09:30                     Well for example, if I was somebody who owned a business or I was the management of a stock and I saw that our return on equity was lower than others and I did the Dupont analysis and I saw our return on sales is lower than others, well then I, I would, I would kind of know that, okay, maybe it’s a good time to cut some of our expenses and do some cost-cutting that maybe that can bring our return on equity up, which brings earnings per share up net earnings up. All the earnings numbers will tend to go up, uh, when you cut costs and that can be very good for the stock. So that’s really like the first major component of return on equity is the return on sales.

Dave:                                    10:15                     Exactly. And seguing into the next component of this formula that we’re talking about, this process that we’re talking about is the sales versus the assets or the asset turnover ratio. This is a ratio that is another efficiency measurement and it’s used to determine how effectively a company uses its assets to generate revenue. Uh, so the formula is pretty simple. You just take an asset. Turnover ratio is divided by, so you take the total revenue divided by total assets and generally the higher this number is the better the company is performing because like Andrew was talking about with the sales, you’re looking at those sales and comparing it to the assets of the company has now A. Andrew was talking about an oil company. I think of somebody like Hormel who has, they have physical assets in that they have plants to process, uh, the beats that they work with.

Dave:                                    11:12                     They also have farms to farm the, you know, to grow or grow to, you know, to breed into, you know, get the cows and everything ready for what they’re. And so those are, those are all assets and those are, you know, not necessarily fixed in the livestock area, but certainly the plants and the farms in the land that they own and things of that nature, that processing plants such all that stuff was going to be is going to be assets and when you’re looking at the sales of versus that. So the higher that ratio is the better that the company is using those assets to create a better efficiency ratio. And this is part of the analysis and one of the things that I wanted to mention about the analysis is, you know, Andrew was right on the mark about when you’re looking at different companies in the same industry and you’re breaking down why the company is doing better or worse than companies in its in its same area. In that same industry. These different components that we’re looking at can be positive or negative. And generally when you’re seeing either the net margin or the asset turnover ratio increase, those are all really good things because it means that the companies being more efficient and it’s based on their sales and also based on the assets that they’re using.

Dave:                                    12:42                     And so these can be positive things and you can see the changes in those as you’re going through your email analysis of these different companies. So let’s say that you’re looking at, I’ll use hormel again. So let’s say we’re working at Hormel and over the course of time you see that their return on equity is increasing. So as you start to break it down, using the Japan analysis, if you can see that the asset turnover ratio is improving, that means that the company is getting better at using their assets that they already have and for using money to invest in those assets and creating more assets and their ratio keeps improving. This is going to help improve their return on equity. And this is a great, uh, this is a great aspect of this, this analysis that we can use. So the first two that we’ve talked about can definitely be very, very strong pluses. So Andrew, why don’t you talk about the equity multiplier?

Andrew:                              13:37                     Yeah, sure. Uh, also known as assets divided by equity. So basically what this is, is, is.

Andrew:                              13:47                     Well, I always talk about with my debt to equity ratio, and I call it my debt to equity ratio because I calculate it maybe a little bit more conservatively than, than some other people like to. I like to consider that as all liabilities and not just what’s commonly known as debt, but uh, in the same token, what you’re trying to figure out here is how much assets to the equity they have. So real quick, just as a refresher, the way that you calculate equity is, is you take your assets and you subtract the liabilities and that’s how you get your equity. So you would do the same with like a more, some of these mortgage, right? You have the, uh, however much the mortgage costs. I’m sorry, however much the house is valued that however much is left on the mortgage. And then whatever is, what’s the difference of that? Is is your equity, so the company is, it’s the exact same thing.

Andrew:                              14:42                     The reason why this is different from debt to equity is it’s just flipping the ratio, right? So a high debt to equity is bad, uh, in this case, high assets compared to your equity is good. And the debt part, the liabilities part, that gets factored in to the denominator, the equity part. So obviously, like I said, more is better and it can contribute to a higher return on equity. Right? So if you think about the equity part, right? And this is where I’m going to kind of give a caveat and maybe I get a little too into the weeds. I play a little bit of devil’s advocate like I like to do, but this is where I think in my opinion, the return on equity formula can kind of break down. And why I say it’s not like an end all be all. I’m for sure.

Andrew:                              15:34                     When you see rising returning, like we, that’s a fantastic thing to see. You can also see that though by companies who are selling off assets. So if you think about return on equity and you think, how has net income on the top and the equity on the bottom, if you’re reducing that equity, it pushes your return on equity up, uh, even though the net income doesn’t change and so a company could be getting smaller and actually their, their future profitability could be worse. Um, but the return on equity you would look better. So when you see increasing return on equity, you also want to see an increasing shareholders’ equity book value along with that, uh, that, that will kind of be like a good, a good catch, right? Like, let’s make sure that, okay, um, this is truly growth and real business growth and a good indicator for future profitability.

Andrew:                              16:29                     So that’s one of the extra steps you can take to see one good metric and confirmed that it is in fact telling you what you wanted to tell you. I think you can do that with a lot of financial ratios. You don’t need to go even in depth like this where it’s like three steps. I, I really think you don’t need to go more than two or three steps when it comes to something where you can see something that looks good and then if you just take it another step further and we’re going to check one other thing and that can kind of complete the picture in a way where you can see and make good decisions on whether something improved or not. So return on equity kind of increasing or decreasing can be that way. So in this sense, um, this part of the return on equity, obviously you can drive this up by having more assets and I’m having lower equity. So there is an up and down to this. The upside is because it’s like a leverage ratio. It’s, it’s taken into account how much that’s being borrowed. So there’s obviously two camps. There’s an, especially today in the low interest rate environment we’re in, there’s the camp of people

Andrew:                              17:50                     Say, well, you know, interest rates are so low, you need to lock in and load up on that because it’s a low interest rate and you’re kind of taking advantage of that and they can kind of unlock more earnings. Obviously when you have more debt, you get to spend that debt and you can use it to create more earnings. On the flip side, you have the boring people like me who are way, way conservative. I like to sleep my seven and a half to eight and a half hours per night and have it not interrupted by thinking about the stock market hasn’t happened yet. So that’s good. But you know, I’m very, very anti debt and the way I see it is, and the way that, the idea of the people who are in this camp is that that is a liability. And when you’re paying debt payments every month than the risks, when times get tough that you can’t make those debt payments can make you default and things can really spiral out of control. And so that’s like, you know, the one side and the other side, I think one fantastic example of this is long term capital management.

Andrew:                              18:57                     We’ve touched briefly about them before, but they were a fund hedge fund that really loaded up on debt and based on their models and their analysis, everything, everything was so low risk. So they had done all these kinds of tests on, on what’s happened historically and they figured out, you know, by being very clever about generally how high something could go, how low it could go. And then they made a lot of bets based on that. And then they use leverage to amplify it because they were only picking up little pieces of, of return, maybe like a two tenths of a percent or something on the trade. But when you lever it up and you add that to it, then you can really magnify it. And so they’re, they’re picking up these little breadcrumbs basically. But because they had leveraged, they’re able to pick up handfuls. Right. But the problem was is they didn’t account the risk models then account for an extreme kind of black swan type of case.

Andrew:                              19:59                     So in the seem to lead talked about this in his book, Black Swan, but essentially when you’re investing in the stock market and putting money at risk in general, there are just certain, I think they’re called like six sigma events, these events where they’re completely unpredictable, maybe unprecedented. We’ve never seen them before. That can hit at any time and most people don’t account for them and a lot of people get burned by it and so it was actually that that six sigma event of, of this financial crisis with which put prices at such a range where it was way outside of where long-term capital managements risk models had had even thought that I could go and because they were leveraged, the impact of that money loss was just multiplied just like the returns were. And it was so great that that they ended up going bankrupt.

Andrew:                              20:57                     And these are all smart dudes. These were all guys with phds and stuff. So a really big smart finance dudes. They’re all really well known and you know, the metaphor goes, you know, you’re there picking up little bread crumbs with, they are doing it in front of an oncoming train. And so that’s kind of an extreme case, but, but an example of what can happen with leverage, obviously I think a lot of businesses out there, they tend to balance it well where they have reasonable leverage levels, maybe reasonable that compared to their assets and equity and things of that nature. But you know, something to keep in mind. I think, um, maybe you can find this third part of the Dupont analysis can maybe explain if you combine them with some other things. So maybe I can explain why. Why is this business doing a, let’s say it has a 30 percent return on equity.

Andrew:                              21:50                     The rest of the businesses in their industrial lands of 20 percent. Why is this business so great? Uh, at return, low return on equity. And then, and then if you see on this, this third component, the leverage component that is much higher than you think, oh, well, okay, they’re able to do that now. But are they gonna be able to sustain that, especially now that they have a lot of leverage, they have allowed that they’re going to have to make a lot of interest payments on debt payments in the future. And on the flip side you can see why is this business have such a low return on equity and you can again look at this third component, the assets divided by the equity and if you see it maybe being much lower than their competitors, then you can get some insight. Okay. Maybe they’re just very, very conservative and that might turn you off and that might be okay too, depending on how far in which camp you lie.

Andrew:                              22:41                     But that’s just some examples. Those are the three main components of some examples of how you can use some of these parts of the Dupont formula analysis to, to take a deeper dive. And that’s what these cfas are required to know. And it’s good. I mean, uh, things like asset turnover that Dave mentioned, that’s something that’s big for the people that are running the business, the people in the operations. And so that’s one last kind of part of the DuPont want to cover real quick is basically depending on which, which part of this you go, and you can actually break it down into five steps. I don’t think we should do that today, but, uh, depending on which component it’s falls in, whether it’s the first, second or third, somebody who is an owner of the business can identify which part of the business needs focus.

Andrew:                              23:44                     So if the asset turnover is really weak compared to the other two components, and that’s what’s dragging our return on equity, then because we know it’s asset turnover and that has to do with operations, then we can know that, okay, it’s the managers of the operations that, that need to improve this. Other examples is like the one I just covered with the leverage that that’s like in the finance camp. So those are the, the, um, people who are making the financial decisions of the company. And so it could be, you know, the operating business inside of the core business model. It could be doing fine, but because they have poor capital allocators, they have poor poor decision making going on in the finance department then that can, you know, obviously cripple now their needs are or any of those other things. And so this can identify, okay, if we see a problem with the leverage part, then that can be a finance issue.

Andrew:                              24:42                     Same thing with the return on sales. Uh, that gets broken down and there’s part of it that has to do with management, but you have also the tax burden and the interest burden. And so if those aren’t being managed well then that can be something that, okay, this was the finance problem instead of a operation problem. And that can be something that maybe it’s not relevant for us because we’re, most of us probably are on the board of directors and making these big decisions for these companies. I think it really helps to obviously put yourself in the owner’s shoes and maybe make better decisions on stocks and gave yourself more insight on what the company return on equity is really telling us and getting insight on maybe why, you know, you’re kind of taking it to that next step. You’re, you’re maybe more separating the operating from, uh, some of the capital allocation decisions.

Andrew:                              25:39                     And like an example I can think of where we’re, maybe this can really help an investor is if you see a big catalyst where maybe management’s getting completely replaced or a lot of, uh, let’s say a lot of other pieces of the business are being replaced, but the core business is staying. You can kind of look back and see how the core operating business contributed to the return on equity and how maybe some of the finance industry, uh, decisions kind of contributed to it. And maybe you can make yourself feel better about going one way or another with a stock because you’ve seen, okay, well this, you know, the guy who is leading the finance department in this company. He was really bad, but they just replaced him. Plus I really like the valuations of this business and so I see it as a good comeback kind of stock you can use.

Andrew:                              26:38                     You can definitely use DuPont to do something like that. Or you can look at a business, say, okay, well there are divesting a lot of their business. They’ve sold off a lot of assets. Historically the return on equity hasn’t been great, but you know, their asset turnover is great. So maybe the core business is doing fine and so maybe you know, I feel really good about that business moving forward and I see it as a comeback story too. So I. there’s so many things you can do with the DuPont analysis. I think those are just a few examples and I think any sort of activity that puts you into the financial statements and has you thinking about some of the main metrics and numbers and anything that really make you look at a 10 k, I think it only improves and makes you better as an investor and I hope, I hope we covered that as good or better than they would cover and like a CFA course. And hopefully it’s helped some people out there and maybe we should answer the questions now.

Dave:                                    27:44                     Okay, sounds good. Alright, so let’s take a look at the question here. Okay. So the question is, hey, so I’ve been listening to your podcast for the better part of this year now, and this is actually the first time I’ve ever contacted a person on a podcast. First, a little bit about me. I am studying my master’s in applied finance in Australia, Perth, and I’m studying for my CFA level one next June 2019. I find your podcast extremely helpful, especially when it comes to interpreting ratios and stock evaluation methods.

Speaker 1:                           28:21                     Hey you, what’s the best way to get started in the market? Download Andrew’s free Ebook at stockmarketpdf.com. You won’t regret it.

Dave:                                    28:31                     I’m wondering if this is still a valuable, the composition of ROE or return on equity. Given the increase of online business models and companies, negative networking capital makes leverage almost nonexistent. Do you believe this will eventually be outdated and is there any other suggestions to break down our ROE when it comes to white asset structure companies with little to no debt in addition, how valuable is this decomposition when companies are in the pre earnings stage?

Andrew:                              29:03                     Alright. Well yes and no. Like he makes good points but I’m based on what I’ve seen in the market. It’s not like black and white light, like, like I’m like this is sounding like. So obviously we do have these tech businesses that are able to turn much higher profit margins. I’m going back to the example I used earlier, like Facebook doesn’t need a lot of capital upkeep but you still have the realities of running a business and everything that that entails. So when you talk about a business like a Facebook or twitter, you know, any of these kinds of online businesses, yes, in theory they don’t need as much leverage, but a lot of them do.

Andrew:                              29:52                     And so you have to think about what’s the, what’s the thing that’s, um, I guess not like what’s the competitive advantage, but what’s the hurdle that these companies need to jump over in order to kind of compete, right? So for Facebook it is the acquiring of all these global users. I think for a business to try to compete against that, they would have to obviously bring a lot of attention and eyeballs to a new platform and get them to log in everyday life people do on Facebook that would cost a lot of money. And so you have businesses like Netflix, for example, where they, if you think about it, they’re just hosting, you know, they’re hosting shows and they’re making these deals with, with other media businesses that nobody’s said they had to, um, create content.

Andrew:                              30:50                     You can argue whether that was a good, good idea or not. But you know, here’s an example of a business where they have very high profit margins in the sense that the equipment doesn’t cost a lot of money to keep up and maintain. You don’t need to have these huge factories or drill bits or anything like that, but you know, they’re choosing to spend a lot in order to try to compete and get better and grow, grow at faster rates. If you look at Facebook today, um, I just saw a commercial on TV the other day where they’re actually making this tablet that looks really cool by the way, but basically you just set it somewhere in your house and then you press one button, then you can video conference with somebody else. Uh, you know, obviously anywhere. Anybody else, I don’t know if they have to have the same Facebook tablet or it can be on the phone, but it’s cool because, um, it’s so convenient and, and obviously you get the bigger screen there, showing them the commercial, how you have your, your hands are free so you can kind of be doing other things.

Andrew:                              31:58                     And so Facebook has a lot of very high profit margin and a lot of earnings, but they’re reinvesting in these other more capital intensive businesses and you know, that that could lead to more leveraged and things of that nature. So yes, there are these businesses that are not as capital intensive. However, we’re still investors and we still see what’s on the balance sheet on the income statement and these are all businesses that are all competing. So, you know, if something’s really that cheap and that easy to manufacturer, well it’s going to draw a lot of competitors and that’s to drive profit margins down. There’s, there’s just no like, perfect business model. There’s no perfect, idea that, you know, leverage will ever be nonexistent.

Andrew:                              32:53                     I think it’s like, it’s like ammo that’s just sitting there for these people who run these companies that, you know, they get financially incentivized if they can really push earnings per share up in a really quick way. And if it just takes using some of that ammo to do it and maybe they won’t be around in 10 years anyways. I see the negative effects of that. I think that’s always in play, so a lot of different reasons and ways that something that maybe initially is a high margin business can become lower margin business. I think just the way that general investment dollars work, they’re just not going to be this. I don’t see this idea of a new,

Andrew:                              33:38                     A new economy like if that happens, it’s going to take so many decades, but this new economy where there is so little equity and so much profits and cash-flow that we don’t need to use a return on the equity ratio anymore. I don’t see that happening for a long, long time and I think if you go back to the episode we did on what drives, whether we call it like what drives share price growth or thing, something of that nature. We’re talking about where that 10 percent, seven percent growth rate comes from that you generally hear about in the stock market. You know there’s a. there’s always a reality that money’s always going to be. Money is always going to try to make itself compound and grow better and faster and so you know, you’ll always have capital competing on itself, a competing with herself and it’s just a huge global marketplace of, of competition and so you know that that can drive return, return on equity down. That can make leverage beneficial.

Dave:                                    34:47                     The components that break that makeup return on equity. Even though there may be companies out there that are asset light like he was referring to, there still going to have higher profit margins and their shareholders, there’s still going to have share holders equity and that’s never gonna go away just because they’re an asset light company. The, you know, the other two components of the DuPont analysis are still going to be in play and you know, just looking at numbers here on Facebook, you know, you can see that their return on equity is really high. It’s 25 point seven, three percent and the majority of that is being driven by the sales ratio. So their net income versus the revenue, is it the 37 percent compared to when I was looking at Hormel, which is, you know, like 10 percent. So I mean that’s a huge difference. Yeah. And you always see those differences. I think it’s like there’s no, I’m sure when Hormel was kind of a booming part of a booming kind of food industry, and their profit margins are probably much, much higher, you know, back then and now it’s kinda matured and become now that fear, it’s more of a commodity and so much easier is early made easier. We made it, it, it’s, it’s driven margins down.

Andrew:                              36:14                     And so he also asks how valuable is this decomposition when companies are in the pre-earnings stage?

Andrew:                              36:22                     Sounds like he’s trying to like trick question has. Gotcha. But you know, obviously you can’t really use it that well. If, if, if a company has negative earnings, I’m going to be really hard to do. And so when he, when he refers to pre-earnning stage, I’m assuming he’s talking about this idea that uh, you have growth. When you have a lifecycle of a company of gross stage, you have the kind of maturing, a maybe more developing stage of the maturing stage and like Kinda the saturation and then maybe a decline. So there’s this idea that, you know, you see it in the venture capital world were turning a profit is not even a goal, you know, and it’s all about just creating revenue growth and I’m making the business bigger and better so that one day it can be profitable. So I just think it’s kind of okay.

Dave:                                    37:19                     I don’t see the point in answering the question because uh, I don’t invest in any sort of pre earnings stage businesses or stocks and I don’t think it’s a good endeavor for people to make it. It’s almost like a lottery ticket. Investing in a way. You don’t have reliable earnings, you can’t really not profitable if you can’t know how profitable it is now, how are, you know, if it’s ever profitable in the future. So yeah, I don’t think the DuPont would really be useful for companies in that stage and I don’t think we should be looking at them as investments anyways. I would agree with that. And I think, you know, as an example that springs to mind when we’re thinking of that as Spotify a, they just recently went public and they’re losing money hand over fist and it’s all about growing. It’s all about growing their subscriber base and growing the revenue and it’s not about becoming a profitable company at this point and anybody that’s investing in it and the other businesses and companies that have invested in it.

Dave:                                    38:22                     Like the venture capital that Andrew was mentioning, that’s really their whole goal is to build it up big enough that at some point it will start to, you know, become a profitable company. And one could have 10 years ago that was kind of the stage that Amazon was in a. That they were kind of in the same kind of boat and you know, they might still sort of be in that boat a little bit. And so in those respects, it’s not really a useful analysis because like Andrew was saying, everything’s negative, you know, except for the, you know, they may be building up some assets but you know, their revenue and their earnings and the free cash flow, it’s all going to be negative because everything is going to build, build, build, build, build as opposed to creating wealth for the shareholders. And so in that respect, it is kind of a trick question because it’s not really something that you can really use for those, you know, those types of companies. It’s not really because it’s going to be negative.

Andrew:                              39:26                     I love that example. You, you provide them with Spotify. I think that’s another. You would think it kind of answers the first part of the question because you would think, well how, how costly can it really be to, to have an APP? I mean if you know anything about APP development, you kind of spend the money upfront, you develop the APP, you put that on the APP store, and then if you can get it to be popular then it doesn’t cost much to keep that maintained. And have it get updated so there is a company who are, you would think while it’s an online business and it has. It should have no leverage because you don’t need as much expenses as more capital intensive business. That’s obviously not the case and it’s broken down and I think regular financial metrics like ROE, we can kind of help you determine that, wow, yeah, this isn’t a successful company. This is a company that’s doing making poor decisions. That’s my daughter.

Dave:                                    40:18                     I’d say. Yeah, exactly.

Dave:                                    40:22                     All right folks. We’ll. That is going to wrap up our discussion for tonight. I hope you enjoyed our analysis of the DuPont analysis and breaking down the three stages of it and looking at it a little more in depth. Hopefully you find the value in that and how it can really eliminate two you really the power or not power of return on equity is coming from. And one of the things I wanted to mention about this is whenever you’re looking at and as simple ratio, like a return on equity or return on assets, it’s always good to kind of look at the parts to see where this is really being generated from, to make sure that when you’re looking at a, a high number that there’s really something of benefit for you as the investor in that. And so without any further ado, we’re going to go ahead and sign off you guys. Go out there and have a great week. Invest with a margin of safety, emphasis on the safety, and we’ll talk to you guys next week.

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