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What is return on assets (ROA)?

ROA definition

When thinking about whether to invest in a stock, you should consider several financial metrics to analyse the company’s performance, including its return on assets (ROA). That raises the question, what is ROA and how is it calculated?

ROA is a ratio that measures how profitable a company has been over a given period in relation to the value of its assets, expressed in percentage terms. What does ROA mean? Simply put, it is a measure of the company’s performance because, the higher the percentage, the more efficient the company is in using its assets to generate profit, also known as net income.

Where is return on assets used?

You may have come across ROA when reading companies’ financial statements and coverage of their quarterly and annual earnings. It can also be used in analysis comparing the performance of businesses that operate within the same industry and have similar assets on their balance sheets.

What do you need to know about return on assets?

When analysing companies to invest in, ROA is a useful measure of profitability, alongside return on equity (ROE) and net interest margin (NIM). Unlike ROE, ROA takes a company’s liabilities into consideration. The more debt a company has, the lower its ROA will be, relative to the ROE. Capital intensive businesses and start-ups that require large investments in assets will have a lower ROA.

If a firm does not include the ratio in its financial reports, you might need to know how to calculate ROA yourself. According to the return on assets formula, you have to divide the company’s net income by its total assets, then multiply the result by 100 to express it as a percentage:

ROA definition

Here is a simple return on assets example. In 2019, US bank Wells Fargo (WFC) reported net income of $19.5bn and total client assets under management of $1.9trn, for a return on assets of 1.02 per cent.  By comparison Bank of America (BAC), with a net income of $27.4bn and total assets of $2.4trn in 2019, reported a higher return on assets of 1.14 per cent.

A ROA calculation is well suited to measuring the profitability of banks, as factors like interest are already taken into account, and it directly reflects the banks’ ability to generate profits from their asset management operations.

In other industries, return on assets is not a balanced measure as it compares returns to equity investors with assets that are financed by debt as well as equity. The value of intangible assets in many businesses is not as straightforward to quantify as tangible assets.

ROA is less effective in comparing companies in different industries, as they will require different levels of investment for assets. For example, an oil and gas producer requires a far higher investment in assets than a software start-up.

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