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Return on Assets (ROA)

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How profitable is the company you're about to invest it? This is what return on assets (ROA) measures. It is not the only measure of profitability, but it is one of the most widely used. The ROA tells us how much profit the firm generates for each rupee of assets they control. For example, a firm with an ROA of 5% means that they generate profit of Rs 5 for every Rs 100 of assets they own.

ROA is often used to compare firms within the same industry. Firms within the same industry are likely to have similar asset profiles. For example, all airlines own or lease aircraft, and these are assets they use to run their business. A higher ROA implies a more profitable company, all else equal.

ROA is not a useful comparison of firms across different industries. This is because asset profiles across industries varies considerably. Suppose we compare an airline and a technology company. The airline owns multiple aircraft, and thus has a large stock of assets. The technology company has a much smaller stock of assets, consisting only of computers and office space. The ROA between these firms is too different to make a useful comparison.

The ROA is computed entirely from a company's accounts. This is unlike indicators such as the PE ratio, that uses the share price as well as accounting information. This means that the ROA does not tell us anything about whether the firm's stock is cheap or expensive. It tells us only whether the firm is profitable or not.

The Return on Assets Formula

The ROA is the net income from the firms most recent income statement, divided by the total assets at the end of the period. The income statement is measured over a period of time (e.g. one year), whereas assets are measured at a single point in time. An alternative calculation uses the average total assets, where we compute the average value of assets between the start and end of the year.

ROA = 100% * (net income / total assets)

Calculating the Return on Assets, An Example

Suppose Bajaj Auto's most recent net income is Rs Cr 3,828. And their total assets are Rs Cr 20,815. Using our formula gives us an ROA of 18.4%

Bajaj Auto ROA = 100% * (Rs Cr 3,828 / Rs Cr 20,815) = 18.4%

Comparing Return on Assetes with Other Indicators

How does the ROA compare to other indicators, such as return on equity (ROE) or return on invested capital (ROIC)? These three indicators all aim to answer the same question: how profitable is the company? All three indicators use only accounting variables, and no market variables. This means that they do not tell us whether the stock is cheap or expensive. They tell us only how profitable the company is.

ROE uses total equity in the denominator instead of total assets. Equity is the difference between assets and liabilities. It represents the book value of the company. If the firm has high debt levels, then equity is low relative to assets, and ROE is much higher than ROA. For firms with low debt levels, ROE is closer to ROA.

The ROIC is a more complex measure that aims to better capture a company's profitability from its core operations. Instead of using net income in the numerator, it uses net operating profit after taxes. This removes any income that does not come from a company's core operations. The denominator uses total capital instead of total assets. This is done be removing cash and current liabilities, so that only capital used to operate the business is considered.

FAQs on Return on Assets

1. What does return on assets (ROA) mean?

RoA is a widely used measure of profitability. It tells us how much profit a firm generates for each rupee of assets it controls.

For example, a firm with an ROA of 5% means that they generate profit of Rs 5 for every Rs 100 of assets they own.

ROA is often used to compare firms within the same industry. Firms within the same industry are likely to have similar asset profiles.

For example, all airlines own or lease aircraft, and these are assets they use to run their business.

A higher ROA implies a more profitable company, all else equal.

2. What is the formula used to calculate return on assets (ROA)?

The ROA is calculated by dividing the net income from the firms most recent income statement by the total assets at the end of the period.

The income statement is measured over a period of time (e.g. one year), whereas assets are measured at a single point in time.

An alternative calculation uses the average total assets, where we compute the average value of assets between the start and end of the year.

ROA = 100% * (net income/total assets)

3. Is ROA better than ROE?

The RoA (return on asset) and RoE (return on equity) ratios both answer the same question - how profitable is the company?

They use only accounting variables, no market variables. This means that they do not tell us whether the stock is cheap or expensive but only tell us how profitable the company is.

While no one ratio is better than the other, if the firm has high debt levels, then equity is low relative to assets, and ROE is much higher than ROA.

For firms with low debt levels, ROE is closer to ROA.

Together they provide a clear picture of management's effectiveness. If ROA is sound and debt levels are reasonable, a strong ROE means that managers are doing a good job of generating returns from shareholders' investments.

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