Measuring Profitability: Return On Assets
Return On Assets (or ROA) measures a company’s ability to generate profit net of expenses. If a firm’s ROA is 5 percent that means that for every dollar in assets the firm generates 5 cents in profits. Now like any ratio, this should not be used as a single deciding factor for investing in any stock, but should be compared to other stocks in the company’s sector or industry to see how it measures up to competitors. A quick look at a company’s historical ROA’s should also be in order when researching any company. Make sure the number is at least growing.
An extremely agile company with good management will deliver higher ROA’s on average than company’s who have stagnating management or are suffering from other business issues. Low ROA’s in a sector with higher average ROA’s could signal a company facing stiff competition or one that is suffering short inventories or production issues. It can also flag companies with extremely high debt.
So how do we measure ROA? It’s really simple. Divide the current fiscal year’s NET INCOME by the TOTAL ASSETS to arrive at the ROA. Now ROA can fluctuate widely during the course of a year or more and when examining a company it pay to research historical ratios to compare how the company is doing versus a past period and even against other companies past periods.
Sound off: what ratios do you use when examining a stock for investment?
