In September, Toys “R” Us filed for bankruptcy protection, hoping to find a way to reorganize their operations and reduce their debt payments. By this March, it was all over – Toys “R” Us announced on March 8 that it would shut down its stores and liquidate its operations to pay its creditors.  At the end, Toys “R” Us was generating a Return on Equity (Net Income/Equity) for its shareholders of negative 47.37%.

How did it come to this, for a once-great retailer? Most commentary on the issue blamed one of two causes: a squeezing of the toy market under competition from and smaller, boutique toy stores, and the increased debt load from the company’s time as a Bain Capital private equity project in the early 2000s.

In reality, it was probably a combination of the two.  How could we find out?

One way is to break down that negative 47.37 ROE in what is known as a DuPont Analysis, or a DuPont Decomposition, named after a process developed by the DuPont corporation.

If ROE is Net Income/Equity, it can also be broken into three pieces:

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As you can see, this bit of algebra can simplify down (by cancelling the two Revenue items and the two Assets items) into the normal ROE equation, so we know the two versions are equal, but this breakdown allows us to examine each of the pieces of ROE separately.

The first piece – Net Income/Revenue – is called the Net Margin. This gives us an idea of how profitable the business is, or how much income they make from their sales and business.

The second piece – Revenue/Assets – is called Asset Turnover. This is a measure of the productivity of a business, or how efficiently the business is able to use their assets to generate sales.

The third piece – Assets/Equity – is called the Equity Multiplier. This measures how leveraged the company is – in other words, it provides a measure of how much debt the company has taken on, allowing it to multiply profits (and losses).

Let’s look at Toys “R” Us using this decomposition, as well as three other companies that all have similar ROEs: Walmart, Nike, and Microsoft:


Net Margin

Asset Turnover

Equity Multiplier

















Toys “R” Us





Looking at this decomposition can tell us a lot about the sources of a company’s returns. For example, Walmart, unsurprisingly, makes very little profit from their sales, but makes up for this with a high amount of productivity – their asset turnover. Because they are a stable business with reliable returns, banks have offered them a large amount of debt, which has allowed them to magnify their returns.

Microsoft seems to be a bit opposite – it creates a product with a high profit margin, partly because it adds so much value to the products it sells (it takes 1s and 0s and creates software, whereas Walmart mostly just moves goods around for sale). However, it isn’t very efficient, since it needs to invest heavily in intellectual property and patents to do so. Like Walmart, however, it is a stable, reliable company and benefits from the multiplied returns from debt.

Nike is somewhere in the middle, except in their equity multiplier. Banks seem to have been less-willing to loan money to Nike. Why might this be? Well, one explanation is that Nike is very style-driven. As shoe trends change, Nike may not necessarily keep up, and this could affect their ability to pay interest payments. As a result, banks are a bit more cautious and have given Nike less debt, reducing their equity multiplier.

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All three companies have similar ROEs, however, despite the fact that they get them from different places. The decomposition allows us to see exactly where and how those returns are generated.

Let’s look again at Toys “R” Us. They have two big glaring problems – one, their Net Margin is negative, they are losing money. This is the effect of competition and the toy-market squeeze mentioned earlier. Second, they have an incredibly high debt load – an equity multiplier of 5.35. This is a consequence of Bain Capital’s purchase and sale of them in the early 2000s – private equity often adds a high amount of debt to companies in order to generate returns for its investors. Often, the companies are selected based on their reliable, stable returns – in other words, they can often pay this debt load without trouble, and Toys “R” Us in 2005 likely seemed to be such a company.

For example, let’s change one number. Let’s imagine for a moment that Toys “R” Us had a Net Margin of 1.5% - not very aggressive, considering that would mean a smaller margin even than Walmart, a company famous for its low margins. With that level of Net Margin and everything else held equal, Toys “R” Us’s ROE would be 12.94% - right in line with the other companies.

This analysis suggests that the debt alone wasn’t enough to destroy the company. The debt just multiplies whatever is happening with the other two values. That meant, when things went wrong, they went really wrong.  A combination of both competitive pressure and high debt load was required to bring about the end of Toys “R” Us.

A DuPont Decomposition is a powerful tool, but it is not infallible. In fact, it contains items (Net Income, most specifically) that are easily manipulated and not necessarily good measures of company performance. In a future blog entry, we’ll examine an alternative to traditional DuPont Analysis that might provide us further insights.

Brian Misamore

About the Author

Brian is a member of the HBX Course Delivery Team and was the lead content developer for Leading with Finance and Becoming a Better Manager. He is a veteran of the United States submarine force and has a background in the insurance industry. He holds an MBA from McGill University in Montreal.