What Is Return on Assets?

If you’re an investor, one of the most profound and insightful activities you can do before investing is fundamental analysis. And one of the most common first steps of fundamental analysis is looking at key financial metrics such as profitability ratios.

Long-term investors purchase shares of a company expecting it to produce a growing future stream of cash or earnings that will translate into a rising share price. Without profitability ratios like net profit margin, operating profit margin or return on assets, investors can’t judge whether a company has been or will remain profitable enough to invest in.

The ability to generate profits points to the company’s long-term growth and staying power; therefore, profitability ratios are important for investors to understand.

Two well-known profitability ratios are return on assets (ROA) and return on equity (ROE). They gauge a company’s ability to generate earnings from its assets and shareholder’s equity, but they don’t exactly represent the same thing. In this article we go over a few key aspects: how to calculate return on assets, what this common metric entails and how to use it effectively before investing.

What Is Return on Assets (ROA)?

Return on assets measures how efficiently a company’s assets generate operating profits (net income). Return on assets uses the total return from all providers of capital, both debt and equity. In the case where a company carries no debts or other liabilities, its return on assets and return on equity would be the same.

Comparing profits to revenue is useful; however, having the ability to cross reference these numbers against the resources a company used to earn that revenue provides the investor with information about the company’s current and future financial status. To put it simply, return on assets tells you the earnings that are generated from invested capital or assets.

How to Calculate Return on Assets

Knowing how to calculate return on assets is important to understanding a company’s overall profitability. However, you don’t need a return on assets calculator to figure out this easy financial ratio.

Return on total assets is calculated by taking net income—which includes the sales less all costs and taxes—and dividing it by the total assets of a firm. The total assets of a firm are all of its resources that generate earnings, including current assets (cash, accounts receivable, inventory); property, plant and equipment; and other assets such as goodwill. A company’s total assets appear on its balance sheet, which you can find on most company websites or at the U.S. Securities and Exchange Commission’s (SEC) EDGAR database.

How to Find Return on Assets Data

If you’re wondering how to find return on assets data, there are a few easy ways you can go about locating this common profitability ratio. Type any stock ticker into the search bar on the AAII website and click on the company’s name to go to its Stock Evaluator page. Scroll down to Ratios to see the current return on assets for the company along with its percentage rank among all stocks and the industry median for comparison. A+ Investors can see a stock’s return on assets for each of the last seven years on the Ratios tab.

Additionally, AAII’s Stock Investor Pro reports return on assets data for the trailing 12 months and the last seven fiscal years. It also provides investors with five-year and seven-year averages. Additionally, you can see sector and industry ratios for comparison. As we mentioned above, the net income and total assets data that are used to calculate return on assets can be found on a company’s balance sheet.

Once you’ve completed your financial analysis, learn how you can get access to countless stock screening tools and resources with A+ Investor.

Why Is Return on Assets Important for Investors?

Return on assets gives investors an idea of how effective the company’s assets are at generating net income. If you’re wondering what a good return on assets figure is, the higher the percentage, the better, because it shows that the company is able to earn more money with a smaller asset base. As a good rule of thumb, a higher return on assets typically indicates that the company has more asset efficiency. However, since the level of assets a company has differs based on its line of business, it is best to compare a company’s return on assets to that of its industry peers or companies in similar lines of business.

If you’ve been conducting your research and notice that a company has had a decrease in return on assets, this could mean it overinvested in certain assets that failed to produce significant revenue growth, which could potentially be a sign of trouble.

What Does Negative Return on Assets Mean?

A negative return on assets may indicate that the company is unable to utilize its total assets sufficiently enough to generate a profit. However, it’s important to understand the reason why a company is not generating positive earnings. Therefore, it’s always important to cross reference data using multiple profitability metrics to gain better insight.

Common ROA Limitations

When using any financial metric or ratio, there are always a few limitations; that’s why it’s good to look at return on assets and return on equity, as well as gross, operating and net profit margins to understand if a company is truly generating sufficient revenue and profits. Here are a few return on assets limitations that you should be aware of before utilizing this common metric:

• Return on assets is not helpful when comparing companies in different industries.
• Some industries experience seasonal differences in their operations, making quarterly comparisons within a company difficult. One way to combat this limitation is to compare data from one quarter to the same quarter from previous fiscal years.

Despite these common limitations, there are many benefits of using the return on assets formula. One advantage is the ease with which investors can interpret results and understand whether a company is generating revenue by utilizing its total assets.

Key Differences Between Return on Assets and Return on Equity

As an investor, how do you effectively use return on assets and return on equity when evaluating a company’s profitability? As we’ve mentioned, it can often be good to use in addition to other profitability metrics before investing. One of the key differences between return on assets and return on equity is how they each treat a company’s debt. Where return on equity factors out how leveraged a company is or how much debt it carries, return on assets includes liabilities.

How to Use Return on Assets When Investing

Before investing, always do your due diligence by conducting financial ratio analysis. If you leave with a few key takeaways about how to use return on assets when investing, always remember:

• Return on assets helps investors understand a company’s profits relative to its assets.
• A high return on assets typically means a company’s assets are productive and well-managed.
• There are multiple ways to calculate both return on assets and return on equity; therefore, it is important to know how your data source calculates these ratios.
• It is considered “best practice” to analyze a company based on both the return on equity and return on assets.

While investing, you can use return on assets to find good stock opportunities because the figure will show you how efficient a company is at using its assets to generate profits. You’ll also want to make sure you have the best resources, tools and strategies to effectively add stocks, funds or bonds to your portfolio. Learn how A+ Investor or our AAII Platinum bundled package can help you develop your own investment strategy to fund future financial goals.