Return on Assets (ROA) Definition
It is calculated by dividing a company’s net income for a period by the value of the company’s total assets as follows:
ROA is most useful when comparing two companies within the same industry.
This is because the assets that are required to do business in different industries can be vastly different from one another, making it hard to appropriately compare, say, an airline and a law firm.
For example, say an investor wanted to compare two competing ice cream stores.
Company A has $5 million in net income and $20 million in assets.
Company B has $2 million in net income and $5 million in assets.
At first glance, Company A might seem like the better investment since it has a higher net income.
However, Company A’s ROA is only 25%, whereas Company B has an ROA of 40%.
This shows that Company B is able to use its assets more effectively to generate profit, and so is likely the better investment.