Definitions: Return on Assets

Moving forward in our definitions series, we once again look at a stock definition: return on assets. This measurement, found in your stock of choice's financial ratios page, tells you a lot about the profit of the company. Let's look at this ratio a little closer.

Return on Assets Overview

Basically, the return on assets (ROA) shows you how much the company made in profit for every dollar of assets they hold. It may therefore be assumed that finding a stock with a really high ROA number is always the best way to go. However, different industries show profits differently, and that's a whole can of worms that needs to be explained when it's opened. So let's look at profits by industry.

Profits by Industry

Depending on a company's industry, the profits could be relatively low in comparison to other industries. This is because some companies require more assets, like equipment or machinery, to produce their products. In an automobile company, for example, cars are produced in large plants with tons of assembly line equipment; car manufacturers just require more overhead to complete the job, so their ROA is smaller than, say, an insurance company.

For this reason, comparing the insurance company ROA to the automobile company's return on assets is like comparing apples to oranges. There is no fair way to decide if the car-maker is running the company well (via the ROA number) unless it's compared to another car manufacturer. So, when we look at ROA, we should compare like industries.

Asset-Light Vs. Asset-Heavy

This brings us to two new terms: asset-light and asset-heavy. These definitions are used to define different industries. In our example above, since it requires more assets to realize a profit, the car industry is considered asset-heavy. The insurance industry is asset-light.

Other asset-heavy industries include: manufacturing, railroads, and telecommunications companies. Asset-light could be advertising firms, software companies, and websites/blogs. The determining factor on if a company is asset-heavy or asset-light is the ROA, with asset-heavy industries weighing in above 20% (or 20 cents to each dollar of profit) and asset-light companies rolling in at below 5% (or 5 cents to each dollar).

Comparing ROA by Industry

So, we know that if we want to find out if the ROA for our company of choice is good or bad, we need to compare it to like companies. Gathering financial ratios pages for the industry you want to invest in can help you accomplish this; simply look at each company's ratios and see who comes out ahead. Of course, you will need to compare many of the ratios to make an informed decision; ROA is only one indicator of a stock's health.

As we move forward in our financial definitions series, we will cover more of the ratios on the financial ratios pages. Stay tuned for more definitions!

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