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Sunday, August 16, 2009

Calculating Return on Assets (ROA)

From The Hoss's Mouth

Return on assets (ROA) is a tool investors use to determine how competent an organization is at using its assets to produce earnings. There are two primary formulas for calculating ROA.

Method One: Net Profit Margin x Asset Turnover

Method Two: Net Income / Average Assets for the Period

Both methods are acceptable but the investor must make sure that s/he uses the same method when performing these calculations, otherwise when comparing companies the results may be skewed. Just like when calculating the win percentage of two horses in a race, a handicapper would not use a formula which calculates win percentage by using total wins divided by total races for one horse and a formula that uses total wins at today's distance divided by total races at today's distance for another. This type of comparison would not produce meaningful results.

Generally speaking, the higher the ROA the better, however remember that widely different industries produce widely different ROA's. Industries such as railroads are asset heavy and will have lower ROA's than asset light companies. So always compare companies that are in the same industries; to use an old cliche: compare apples to apples.

There are many free online financial services which provide you with ROA numbers for all companies listed on the stock exchange, therefore Money Magazine Hoss is not going to bore you with sample calculations. Why perform all these mathematical calculations yourself when somebody is doing it for you and for free? For example, a quick look at Yahoo Financial shows that Amazon has a ROA of 6.93%.

Stay on Track,

Money Magazine Hoss

Next Hoss Cents Free Financial Money Magazine Post: August 23, 2009
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Related Posts:
Calculating Asset Turnover
Calculating Return On Equity
Financial Statements Explained

The Balance Sheet
The Income Statement
Calculating Gross profit Margin
Calculating Operating Margin

Investment Strategy Dollar Cost Averaging
Market Timing
Calculating Net Profit Margin

Calculating Net Profit Margin
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1 comment:

  1. An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets. Thus we understand ROA is how much important for a company.

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