Return on Assets (ROA)

Return on Assets (ROA) is one of the key fundamental indicators used by financial analysts. ROA can give you a lot of hints on what’s going on with a particular company and how effective it’s managed.

In this article, we’ll explain what ROA is with some simple examples, and show how this financial ratio can be used in the analysis of a business’ profitability.

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What is Return on Assets (ROA)?

This market indicator aims to give you a glimpse of how well a corporation manages its assets in terms of generating net income out of them.

If a firm’s return on assets stays high for a long time, it tells analysts, investors, and portfolio managers that it might be a good investment opportunity. A low or even negative ROA suggests that the company can’t use its assets effectively to generate income, thus it’s not a favorable investment opportunity at the moment.

Although ROA is often used for company analysis, it can also come handy for analyzing personal finance. To learn more about how to calculate a return (and expected return too) of a personal financial portfolio check out this article:

➤ Read also: How to Calculate Expected Return?

How to Calculate Return on Assets?

You can use this simple formula in order to calculate the ROA:

$$ ROA = \frac{NI}{TA} $$

Where:

• ROA: Return on Assets
• NI: Net Income
• TA: Total Assets

Net income is the difference between revenues and expenses for a given period of time, this is how much money is added to (or subtracted from) a company’s balance (to assets after all) during a certain period. If a firm has $500,000 in total revenues and $400,000 in total expenses, the net income would be $100,000. These values usually can be found in the company’s public income statement.

The total assets are also easy to find, they are located in the company’s balance sheet. Total assets mean the sum of all of the assets that belong to a company (cash, property, inventory, etc.)

➤ Read also: What are Assets?

Let’s assume that a company has $1,500,000 (1.5 million) of total assets and the net income of $100,000, as we mentioned earlier. The return on assets would be 0.06 (100,000 / 1,500,000), which means 6%. It tells us that this company would need approximately 16 years to return 100% of its capital (100 / 6).

Understanding Return on Assets

The return on assets shows how effective a corporation is in terms of making money out of its assets.

It’s believed that if a company can’t demonstrate a high ROA (or if it has no ROA at all or a negative ROA due to net losses), this company is not to be trusted and it isn’t a good investment although it isn’t always the case, especially for startups and recently created firms which might struggle to start generating their first profits during their first years of operation.

Limitations of the ROA ratio

It’s important to remember that ROA doesn’t take into account many other important variables, such as company liabilities. There is a ratio that takes into account company liabilities and it’s called Return on Equity (ROE).

Some companies might have a massive amount of assets with a decent net profit, but their ROA might look quite low. That doesn’t mean that it is a bad company to invest because ROA, like many other indicators, should be analyzed and compared with companies of a similar market cap and within a similar industry.

Examples of ROA Indicators

Here are some companies and their current ROA indicators according to macrotrends.net:

• Coca-Cola: 7.75%
• Google (Alphabet): 12% (with the lowest point of 7% at the end of 2017)
• Facebook: 20% (quite stable)
• JPMorgan Chase: 1.22% (a stable rise)
• Tesla: -3.35% (still a negative number, but it is going up)
• Walmart: 3.78% (a decline from 7%+ in 2016 and before)

As you can see the ROA indicator itself can’t tell you much if you don’t take into account the nature of the company’s industry. For instance, banks have a lot of assets which are client deposits, so their ROA is often low, but for the banking industry it’s perfectly normal. There is no “normal”, bad or good ROA value if we’re talking about this value in a vacuum, it’s just a number, although, a negative ROA is definitely a bad sign.

Also, the ROA indicator can tell us more if we look at it from a historical perspective. The way it changes over the years can show a positive or negative trend in the company’s management, but again, it is not always the case. A company might be already expanded to its limits, therefore there might be little potential for profit growth. Assets would keep growing as the company makes more money, so the ROA would decline, but it doesn’t mean that a company is in trouble.