Investing in stocks for a longer duration can help to create wealth and achieve future goals . To achieve this goal we need to invest in good companies and understanding of Return On Assets Ratio will help you. As a young or new investor , there are different ways people choose to invest in stocks
- Friends advice
- Social media tips
- News based analysis and much more
Are these approaches wrong ? It’s both Yes and No and depends on how you want to approach your investing journey . This journey is long term and not a short one and hence it is important that as we grow older in investing , our knowledge should also increase . It will help us to invest in good companies for higher returns.
Whatever approach you take , one thing is very clear that at least you should try to know the company that you are investing in. Hence , in this article we will discuss Return on Assets ratio with concept , which is one of the things that you can look at while investing in a company . It doesn’t matter whether you are from a finance background or not as we have tried to explain this concept in a very easy and simple manner . So lets start !
Return on Assets Ratio : Definition
ROA which means “return on assets” is a profitability ratio which measures the return that company generates on its assets . But why is ROA important and what are assets?
Assets are things where companies spend money to generate revenue .
For example a software company will spend on computers , office space to create software that they can sell to clients to generate revenue . In this case computers , office space etc. are Assets .Similarly an ice cream shop will spend money on a shop and getting different varieties of ice cream in their store ,so that he can sell to customers and make money. In this case his shop and the ice creams in the shop become Assets.
Return on Assets Ratio : Example
Now lets see this concept with help of an example . Suppose there are two people who want to start an ice cream business .
Person A : He will buy an ice cream truck and then go to different societies to sell the ice cream . This will cost him 1 lac rupees and estimated profit is around 20,000 Rs
Person B : He will open an ice cream shop in a market area which will cost him 2 lac rupees and estimated profit is also around 20,000 Rs
Suppose as an investor , you want to calculate Return on Assets ( ROA ) for business of person A and Person B .
Person A : 20,000/1,00,000 = 20%
Person B : 20,000/2,00,000 = 10%
Now what does this mean ? This means that person A is utilizing the assets better to generate revenue. When assets are utilized better and efficiently, higher revenue is generated and Higher revenue means better chances for investors to make money. One of the goals for any company/business is to generate revenue from assets as efficiently as possible.
I hope the concept of ROA is now clear to you . Let’s understand few things you should consider before looking at ROA .
Important Points
1. Always look for ROA in similar Industries to compare
Suppose you are comparing ROA for companies from 2 different industries . Will this be a fair comparison ? May be not
A manufacturing company needs higher assets to manufacture products . It needs a manufacturing plant , manufacturing machines , logistics to transfer products from company to distributors , warehouse etc. . Whereas , a software company might require office space , computers etc. to generate revenue , so the assets might be much lower.
If both companies generate the same revenue , then you might say that a software company has better ROA than a manufacturing company. But this is not correct ? You should compare software company ROA with other software companies to understand how assets are utilized . Similarly you should compare manufacturing company ROA with other manufacturing companies to compare ROA.
2. Better ROA means company management is allocating the Assets efficiently
ROA can also help you to forecast the future profits of a company . Suppose there is a manufacturing company having 10% ROA and currently assets are of value 1 lac rupees . This means current profit is 1,00,000*10% = 10,000 Rs
Now you get the news , that the same company is opening a new plant and planning to invest around 2 lac rupees . As ROA for the company is 10% , you can assume that the company will increase their profit by 2,00,000 * 10%(ROA) = 20,000 rupees in the future . More revenue means better chances of stock prices going higher.
3.Monitor the ROA trend
Look for quarter on quarter or year on year ROA to understand whether a company is getting better in utilizing the assets to generate revenue .
Note : Don’t look ONLY “ROA” to invest in a company and there are other ratios also which should be looked at along with ROA . We will understand all the important ratios going forward which will help you to make better decisions while investing in a company.
Where to find ROA for Companies
I hope you have understood the concept of ROA in this article . You dont have to go to balance sheet of different companies to calculate the ROA but there are different websites that calculates this for investor . One of the website that you can use is screener.in.
This website will provide you ROA trend from last few years for different companies . You can also see difference between ROA for companies from different industries.