[MUSIC] What is this Dupont Decomposition? Well, it's basically this formula. Return on Equity, if you see at the beginning Return on Equity, it's equal to Net Income over Equity. You can decompose it into three items. The first one is the net income over sales, with is the ROS, Return on Sales, right. If you multiply that times sales over assets, then sales over assets we call Turnover. What is this turnover? What is the meaning of the turnover? Well, you see how much are you able to sell with the assets that you have? If you have a very expensive assets and you do not sell almost anything, the turnover is very small. Imagine that you have, for example, have to rent a really expensive place in Pacio de Gracian, Barcelona, to sell ice creams. Well, the rent of that place is going to be super high, so the assets are going to be very expensive, and if you sell cheap ice creams then the sales are going to be very small compared to the assets. That's the turnover. Now this third element, it's called Leverage which is basically assets over equity. It's a measure of leverage. You see if equity is very small, then these ratios going to be very high. So if equity is small, leverage is very high. And you can lever yourself by asking for long-term debt or by paying late to your suppliers or getting other spontaneous sort of financing. Now this means, that if you want to change something in the company or you want to work on some stuff, there is basically three fronts or three areas in which you could work. The first one is, the ROS. You can increase ROS by increasing margins or reducing OPEX. You can increase turnover by trying to sell more with the same assets or trying to sell the same amount with less assets. And the third one is lever yourself, increase leverage, ask for more money to the bank. Let me give you a super simple example, super simple example in which you would understand this formula much better I think. Imagine that two companies in New York who make suits, like this one, right, with the following return on equity. So company A has an ROE of 20%, and company B has an ROE of 20%. And both of them do suits in New York. In which one would you invest, or how do they differ? Now you would say, Miguel, whatever, [LAUGH], they are exactly the same. I don't know how to distinguish them because you are telling me both make suits, both are in New York, and both have the same return on equity. So I have no idea, to me they are indistinguishable. Yes, if I don't give you more information, I agree. But what if I tell you that one company sells high end suits in the 5th Avenue, Brioni or Armani suits, and the other one sells cheap suits in Brooklyn? And then I tell you, okay, which of the two is the 5th Avenue shop? If I give you the Dupont Decomposition of the two companies. Pay attention now. I'm going to give you the Dupont Decomposition of the two. See, the first one says ROE of company A. Is it 2% of ROS times five of turn over times two of leverage, two times five ten times two, 20. Twenty of ROE. The second one, ROS of 10%, turnover of one, leverage of two, ROE of 20%. Now which of the two is the Fifth Avenue? Well you would agree with me that the Fifth Avenue are selling that Brioni or Armani suits, they are selling very expensive suits, which means that the ROS, the margins are going to be very high. So which of the two have highest margins? Well, you see that is the b one. So the combination of very high margins, 10% of ROS compared to 2% of ROS would be the cheap ones. The combination of that with the turnover makes us realize that the number b is the Fifth Avenue one. Now, look at the turnover now. Turnover means that if you are in the Fifth Avenue, it's very expensive actually to rent or to buy one of those places in the Fifth Avenue. So the assets in that ratio, turnover of sales over assets, assets are going to be huge, and sales not that big. That's where you have a turnover of one. Whereas in Brooklyn, perhaps you have cheaper access to rent a place. So, you're going to be able to sell more volume with a lower assets, that way you have turnover of five. I kept leverage the same so that we basically focus on the first two. [MUSIC]
