What Is Return On Assets?

Return on assets (ROA) is a ratio which measures a company’s profitability, relative to its assets. ROA shows management and investors how effectively a company is deploying its assets.

How Is Return On Assets Calculated?

ROA can be easily calculated using the following formula.

ROA = Net Income / Total Assets

Dividing net income by total assets, ROA comes out to a percentage. A high percentage indicates management’s efficiency with deploying the assets their company’s balance sheet to generate a return. A high ROA also indicates a company operating with low asset intensity.

Analyzing A Company’s Return on Assets

After being calculated, ROA can tell investors and management a great deal about the profitability of a company. As stated before, high ROA generally indicates strong profitability. However, it is important to note that “high ROA” is relative. A company’s ROA is best analyzed when compared to that of very similar companies. So, it is reasonable to conclude that a company with higher ROA than its close competitors is more efficient at capital allocation. Another way ROA can be analyzed is by observing its year over year trend. A company who’s ROA consistently rises or is relatively flat may be more attractive than one who’s ROA consistently declines or is highly volatile.

Example:

As shown in the hypothetical example above, ROA can be effectively analyzed by comparing similar companies. In this example, it can be inferred that ABC Shoes is the most efficient capital allocator in the shoe industry.

Limitations To Return On Assets

One limitation to ROA is its lack of ability to be compared across industries. Another limitation to ROA is its lack of distinction between debt and equity financing. Some assets are bought via debt financing but ROA compares all assets to net income, which is strictly the return for equity investors, not debt investors.