When considering which companies to invest in, there are a lot of factors to look over. It can confusing or intimidating at first, but the more you know, the more able you are to make wise decisions with your money. One of these factors that might seem confusing as first is “Return on Assets.” Read on to learn more about this important term
What is Return on Assets?
Return on Assets can be defined as a measure of how good a company and its management team are on using their assets to make money. By using the simple formula of net income divided by total assets, you get a percentage. This percentage gives investors an idea of how well a company uses its existing resources to make money.
ROA = Net Income / Total Average Assets
For example, Company A has a net income of $2 million dollars, and total assets of $10 million dollars. Using the supplied formula, you get a ROA of 20%. Company B, on the other hand, also has a net income of $2 million, but has only $5 million in total assets. Company B has a ROA of 40%. What this means, is that with only half of the available assets, Company B was able to earn just as much money as Company A. By this math, Company B would be the better investment.
Of course, it’s not always that simple. What is considered to be a “standard” ROA can vary a great deal depending on the size of the company or what type of company it is. For this reason, it’s mostly useful when used to compare two similar companies. Otherwise, the percentages might tell you the ROA, but they aren’t really telling you the whole story.
For example, a service company tends to have higher ROA than a manufacturing company, as the service company tends to have less in plant, property and equipment. Most of its assets are intellectual and intangible.
ROA can be a useful tool, however, because it offers a window into how well the company and its management handle assets, fix problems and look out for the welfare of the company as a whole and its investors. While larger companies might have much more money to play around with, it doesn’t always means that they use that money well or wisely. By taking the time to research a company’s ROA you can gain a deeper understanding of how well that company uses what is has, and what could happen in the future if you were to invest in that company.
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