Return on Assets (ROA)

We know the first component of Return on Assets (ROA). Its simply Net Margin, or Net Income divided by Sales. And it tells us how much of each dollar of sales a company keeps as earnings, after paying all the costs of doing business. The second component is Asset Turnover, or Sales divided by Assets, which tells us roughly how efficient the firm is at generating revenue from each dollar/rupee of Assets.

Multiply these two, and we have the formula for return on assets.

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ROA = Earnings/Assets

Alternatively this can also be expressed as
ROA =(Earnings/Sales) x (Sales/Assets), or

ROA =Net Margin x Asset Turnover
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Think of ROA as a measure of efficiency. Companies with high ROAs are better at translating Assets into Profits. ROA helps us understand that there are two routes to excellent operational profitability. You can charge high prices for your products (high margins) or you can turn over your assets quickly.

ROA tells an investor how much profit a company generated for each $1 in assets. When using ROA as a comparative measure it is best to compare it against a firm's previous ROA numbers or the ROA of a similar company. ROA for public companies can vary substantially and will be highly dependent on the industry.

Calculating Return on Assets

Calculate ROA by simply dividing annual earnings by Average of Total Assets. Calculate Average Total Assets for any fiscal period by adding Total Assets for the fiscal and the previous fiscal and divide by two. Annual Earnings can be taken from the Consolidated Profit and Loss Statement from the firm's Annual Reports. The firm's Total Assets can be found in the Balance Sheet filed in the firm's Annual Reports. Annual Reports can usually be found at the firm's website or from SEBI EDIFAR database. Total Assets refers to all the resources a company has at its disposal -the shareholders capital plus short and long term borrowed funds.

Rough benchmarks for analysing a firm's ROA

All things being equal, the more asset-intensive a business, the more money must be reinvested into it to continue generating earnings. This is a bad thing. If a company has a ROA of 20%, it means that the company earned Rs. 20 for each Rs. 100 in assets. As a general rule, anything below 5% is very asset-heavy [manufacturing, railroads], anything above 20% is asset-light [advertising firms, software companies].

Want to see a practical example? -check out Opto Circuits ROA analysis

You may also like to learn more on
Return on Equity (ROE)
Return on Invested Capital (ROIC)

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