Return on Equity shows how efficiently a company utilizes profits from its assets. A high ROA indicates a company is financially solid. The ROA reveals:
- How much profit a company generates with the money shareholders have invested
- The amount of net income returned as a percentage of shareholders equity.
- A firm’s efficiency at generating profits and using investment funds to generate earnings growth.
- A ROA of five percent is considered good.
ROA = (Net Income/Average Total Assets)
- Net income is derived from the income statement of the company and is the profit after taxes.
- Total assets are read from the balance sheet and include cash and cash-equivalent items such as receivables, inventories, land, capital equipment as depreciated, and the value of intellectual property such as patents.
- Average Total Assets = (beginning of the assets + end of year assets)/2
- A ROA of 20% means that the company produces $1 of profit for every $5 it has invested in its assets
- An increasing ROA indicates a business is continuing to earn an increasing profit on each dollar of investment.
- A falling ROA indicates trouble in a company.