Beginning Investor Terms – Return on Assets (ROA)
Posted on | December 28, 2009 | No Comments
This week’s Beginning Investor Term is Return on Assets (ROA). ROA is another investing concept, like last weeks ROE, that helps determine if Management is running a company effeciently. Or in this case specifically the assets it has at it disposable. Assets include both shareholder equity and debt. Thus a company with no debt would have an ROE and ROA that were virtually identical.
Return on Assets may be even more industry specific that ROE. It is usually used as a comparison within an industry or compared to a companies own historic ROA. The reason for this is pretty straight forward. Some industries require very different resources. A telecom company needs larger outlays of financial resources to produce $1 of income than a software company.
Some of you were hoping I would skip this part. Here is the math. ROA=Net Income/Total Assets or an alternative equation is ROA = (Net Income + Interest Expense)/Total Assets. The latter equation includes the costs of debt and thus, to me, is a better metric, although the first is more common.
When making investment decisions if you discover that a company has a higher ROA than its industry peers, that is good. If it is generating a smaller ROA that is brethren, management is not doing as well. Use the information as part of your overall investment strategy when evaluation management.
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