Which Company Will Make You More Money: 3M or DuPont?

DuPont (DD) and 3M (MMM 0.41%) are two of the most consistent companies on the market. They've been paying investors consistent dividend payouts for 110 and 97 years, respectively, two of the longest streaks on the market. But they're very different companies, and offer different risk profiles for investors looking for consistent returns for years to come. 

Finding the detailed differences between companies as complex as DuPont and 3M can be a confusing task for even the most seasoned investors. But a tool called the DuPont analysis -- named after the company itself, which started using this method in the 1920s -- can help break down a company's financials, and tell investors where they're getting a return for the dollars invested. Today, I'll look at how these companies stack up against each other, and where exactly they're getting returns from.

What is a DuPont analysis?
DuPont starts as an analysis of return on equity, or ROE, or net income divided by the average equity a company has. We use net income because it's a gauge of the total profit a company makes, and equity because it's the capital a company has gotten from outside investors, or kept as earnings. As stock investors, we're expecting a profitable return on the funds we invest in a company.

But ROE alone doesn't tell us if management is operating a company efficiently, or if financial leverage is driving returns. The DuPont analysis breaks down earnings into five components that tell us exactly where earnings are coming from. The components are profit margin, asset turnover, interest burden, tax efficiency, and the equity multiplier. I'll break them down for DuPont and 3M below.

Management effectiveness
To gauge how effective management is at turning assets into profits, the DuPont analysis uses profit margin and asset turnover. Profit margin is the earnings before interest and taxes are applied on the income statement, often called EBIT, divided by sales.

Asset turnover is the amount of sales divided by the average assets. This measures how quickly management is able to push product through its business, and uses assets as a way to measure that effectiveness. The calculations look like this:

Profit Margin = EBIT / Sales

Asset Turnover = Sales / Average Assets

Below are the ratios of both measures for 3M and DuPont.

Source: Company earnings reports. Author's calculations.

You can see that 3M earns more profit from each dollar of sales, and turns over its assets more often than DuPont. From that perspective, 3M is managed far more effectively.

Tax burden and financial leverage
Management effectiveness is important to total returns, but so is the leverage a company employs on its balance sheet, and the tax rate it pays. It's like owning a home: The more debt you take on, the more leverage you have if the value of your home goes up. The downside is that leverage introduces risk into a business.

The measure DuPont analysis uses for interest burden is below, and accounts for the cost of servicing debt. If there's no debt, the ratio is one.

Interest Burden = (EBIT- Interest Expense) / EBIT

Tax efficiency also needs to be taken into account because taxes are a very real cost for businesses, and a lower tax burden means more net income for investors. The calculation of tax efficiency is:

Tax Efficiency = 1- [Tax Expense / (EBIT- Interest Expense)]

Finally, the equity multiplier tells us how much debt (or leverage) a company employed to build out the assets in its business. Remember that profit margin above was measured based on assets, and this ratio will tell us where those assets came from.

Equity Multiplier = Average Assets / Average Equity

These ratios for 3M and DuPont are below.

Source: Company earnings releases. Author's calculations.

You can see that 3M has far less leverage and a higher tax rate, which leads to a higher multiplier for DuPont.

Why 3M's ROE beat DuPont's 
When you multiply all of these components together, you get total return on equity. I've shown the components below, and it lays out where 3M and DuPont differ in the DuPont analysis.

Source: S&P Capital IQ and company earnings releases. Author's calculations.

3M clearly has much higher returns on the assets it has, but it doesn't employ the same leverage, and also has a higher tax rate then DuPont. Therefore, at the end of the day, the returns on equity come closer together than you might anticipate, at 26.6% for 3M and 19.5% for DuPont.

The key for investors to remember here is that if you own either of these companies for its dividend, there are different risks involved. DuPont is using leverage to generate returns that help pay for its dividend, and 3M has a high profit margin and higher asset turnover. 3M is the lower-risk stock, and dividend investors looking for long-term payouts should consider that in their investment theses.