What is Return on Assets (ROA)?
Every company holds assets: resources that generate economic value, measured as return on assets (ROA). Return on assets is a way to measure how much profit a company generates with the assets on its books. It’s calculated by dividing net income by total assets. The higher the percentage, the more effective the company is at leveraging its assets. Conversely, lower ROA figures can indicate inefficiencies—or bad investments.
Return on Assets is a popular evaluation metric for the financial health of a company. Investors will often use it in conjunction with other profitability metrics to better-contextualize how a company makes money. It’s a very simple, very insightful metric that can help investors make a more informed decision about what companies they choose—particularly for growth investing.
How to Calculate Return on Assets
The goal of calculating ROA is to understand how efficient a company is at generating revenue through its assets. To calculate Return on Assets as percentage, investors need to know the net income the company generated, as well as the cumulative value of assets carried on its balance sheet. The equation is simple division:
Return on Assets = Net Income / Total Assets
As an example, say that ABC Company generated $10 million in total income last year, with $100 million in assets on its books. The company would have a 10% return on assets (10/100 = 0.10). This means that every dollar in assets the company has generates 10 cents in revenue. The higher the ROA, the better a company’s asset efficiency.
ROA as a Comparison Metric
While ROA is a great metric for evaluating how well a company’s management leverages its assets into revenue, it’s equally as great as a comparison metric. Investors can compare two competitors with similar business models to see which one utilizes its assets better.
For example, Company A might have $20 million in income and $100 million in assets. Company B might be much smaller—$10 million in income and $40 million in assets. Despite their different sizes, Return on Assets shows us that Company B uses its assets more efficiently to generate revenue: Company A’s ROA is 20%, while Company B’s ROA is 25%. This means Company B is able to create more income with fewer resources.
Other Profitability Metrics
Return on assets is one context for a company’s total profitability. It can’t tell the full story of profitability by itself, which is why it’s best used in conjunction with other metrics, including Return on Invested Capital (ROIC), Return on Equity (ROE), Return on Net Worth (RONW) and Earnings Per Share (EPS), among others.
ROA Varies Greatly Across Industries
Return on assets is a metric that depends entirely on the assets a company carries on its balance sheet. This means that different companies across different sectors of industry will bear different ROA metrics. For example, consider a manufacturing company with hundreds of millions of dollars in equipment assets vs. a bank with very few tangible assets. This is why Return on Assets isn’t comparable across industries—only between competitors.
Because of this variability, Return on Assets is best-used as an analytical device in product-based sectors, as opposed to service-based sectors. This isn’t to say investors can’t evaluate service-based businesses with it—it’s a better metric for evaluating asset-laden companies.
What’s Considered a Good ROA Percentage?
While the context of ROA varies significantly across industries, the measure itself yields generally sound information about a company’s asset efficiency. That is to say, most ROA percentages fall into general categories:
- Bad: Negative ROA or a measure below 5% is alarming for investors.
- Poor: ROA measuring 6-10% signals inefficiency in asset revenue generation.
- Good: Companies with Return on Assets higher than 10% offer a healthy outlook.
- Excellent: When ROA broaches 20%, it’s considered an excellent use of assets.
Keep in mind that “good” Return on Assets is best evaluated through comparison against competitors and similar companies. The above benchmarks are general, and have different meanings depending on the company or its business operations.
Return on Assets (ROA) vs. Return on Equity (ROE)
There’s often confusion between return on assets (ROA) and return on equity (ROE). Both represent how well a company uses resources to generate income; however, they’re very different metrics.
Because ROA uses the company’s total assets, it also takes into account the company’s debt. ROE, on the other hand, leaves out liabilities. This creates a big difference when evaluating, since companies often bring new debt onto the balance sheet to acquire assets. For companies with more debt, ROE tends to be much higher than Return on Assets and thus, might not be a true representation of how efficient the company uses its assets. Many investors prefer ROA for this reason when evaluating company performance from a return on resources standpoint.
How Well is a Company Using Its Assets?
Return on assets is a great way to understand how effective a company is at using its investments to make money. A balance sheet loaded with assets might look good, but a low Return on Assets suggests the company isn’t using them very well. Conversely, a few well-used assets can generate high ROA, showing a company’s ability to make their investments work for them.
To better understand these metrics and how to use them as an investor, sign up for the Liberty Through Wealth e-letter below. The experts at Liberty Through Wealth provide stock insights and tips to building wealth in your life by making smart investment decisions.
ROA is one of many profitability metrics investors should use to contextualize the financial performance of a company—particularly asset-reliant businesses. Asset efficiency is a great metric that can help narrow the decision between multiple investments, down to the company that’ll leverage assets to outperform its peers.[adzerk-get-ad zone="245143" size="4"]