Understanding how well a company uses assets to generate income is vital in measuring corporate health.
One way to do this is by analysing Return on Assets of a business.
So how do we, as investors, go about this?๐
[THREAD]
One way to do this is by analysing Return on Assets of a business.
So how do we, as investors, go about this?๐
[THREAD]
1/ ROA
The first thing we need to do is understand exactly what the ROA ratio means.
The ratio indicates how profitable a company is based on its total assets.
ROA measures how well a business uses it assets to generate profits.
The higher the ROA, the better.๐
The first thing we need to do is understand exactly what the ROA ratio means.
The ratio indicates how profitable a company is based on its total assets.
ROA measures how well a business uses it assets to generate profits.
The higher the ROA, the better.๐
2/ Understanding ROA
Comparing profits to revenue is a useful metric to use.
However,
Comparing them to the resources a company used to earn them indicates the efficiency of the business more accurately.๐
Comparing profits to revenue is a useful metric to use.
However,
Comparing them to the resources a company used to earn them indicates the efficiency of the business more accurately.๐
3/ Small Scale example
Company A and Company B both started hot dog businesses.
Company A spends R1500 on a simple hot dog stand.
Company B spends R15 000 on a limited edition hot dog stand.
Company A earns R150 and Company B earns R1200.
Which business is more efficient?๐
Company A and Company B both started hot dog businesses.
Company A spends R1500 on a simple hot dog stand.
Company B spends R15 000 on a limited edition hot dog stand.
Company A earns R150 and Company B earns R1200.
Which business is more efficient?๐
Company A- R150/R1500 = 10% ROA.
Company B- R1200/R15000 = 8% ROA.
Company B may be more valuable, however company A is more efficient.๐
Company B- R1200/R15000 = 8% ROA.
Company B may be more valuable, however company A is more efficient.๐
4/ How to apply ROA
The ROA of a business should always be compared to the ROA of similar businesses.
This is because each industry has their own averages.
Compare businesses with competitor's and see which businesses have a higher ROA.๐ธ
The ROA of a business should always be compared to the ROA of similar businesses.
This is because each industry has their own averages.
Compare businesses with competitor's and see which businesses have a higher ROA.๐ธ
5/ ROA and ROE
The ROA and ROE are very similar however the ROA considers the debt of the business.
The ROE does not consider the debt of the business.
Using the metrics together offers better insight into the corporate health of each business.
The ROA and ROE are very similar however the ROA considers the debt of the business.
The ROE does not consider the debt of the business.
Using the metrics together offers better insight into the corporate health of each business.
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