DuPont Analysis and Firm Life Cycle

We extend Soliman’s (2008) study of the incremental information provided through DuPont analysis of return on net operating assets (RNOA) by examining pricing and mispricing of profit margin (PM) and asset turnover (ATO) across life-cycle stages (Dickinson 2011). We obtain additional insights by examining the incremental information provided by sub-components of RNOA for PM and ATO in different life-cycle stages. Consistent with life-cycle theory, we find that change in ATO is priced more strongly for mature firms than for other firms. This is due mainly to operating efficiency reflected in property, plant and equipment (PP&E) turnover and partially due to accounts receivable turnover. We find that change in profit margin is positively priced for both growth and mature firms. This reflects negative pricing of cost of goods sold (COGS), selling, general and administrative (SG&A) expense and depreciation expense as a percentage of sales. Research and development (R&D) costs as a percentage of sales are positively priced for mature firms but not positively or negatively priced for growth firms. We also find evidence that PM is underpriced for growth firms. This underpricing is due to mispricing of depreciation expense and R&D expense for growth firms, indicating that market participants do not fully value the information provided by these variables for future earnings.