Return on Assets (ROA) –
Return On Assets is a profitability ratio which shows us how efficiently company is using its assets to generate profits. Higher the ROA or increasing ROA is a good sign for investments and lower the ROA and decreasing ROA is bad sign for investments. ROA is very very important because it includes both debt and equity in calculations. Assets are equal to debt (liabilities) and equity, so ROA gives clear picture as compare to ROE.
Return On Assets = Net Income / Average Total Assets
ROA is calculated by dividing Net Income by Average Total Assets. Net Income can be found in income statement and Average Total Assets can be calculated by taking average of adding current year starting total assets with current year ending total assets.
Lets take examples,
In above example, Net Income of company A is 100 and company B is 70. For company A, total assets at the start of the year is 450 and total assets at the end of the year is 520, so the average total assets of company A is 485. For company B, total assets at the start of the year is 400 and total assets at the end of the year is 480, so the average total assets of the company B is 440.
Average Total Assets of company A = (450+520) / 2
Average Total Assets of company A = 485
Average Total Assets of company B = (400+480) / 2
Average Total Assets of company B = 440
Now we have Net Income and Average Total Assets, so now we will calculate ROA,
ROA of company A = (100 / 485) *100
ROA of company A = 21%
ROA of company B = (70 / 440) *100
ROA of company B = 16%
From above calculations, ROA of company A is 21% and company B is 16% means ROA of company A is greater than ROA of company B, it shows company A is efficiently using its assets as compare to company B.
ROA is important metrics in fundamental analysis, but it should be used to compare different companies within same industries because manufacturing companies have low ROA and IT companies have high ROA.
Always compare ROA of companies with sector ROA, If company A has greater ROA than sector ROA, it means company A is utilizing its assets effectively. If company B has low ROA than sector ROA, it means company B is not utilizing its assets effectively.