Real Life Examples: Analyze ROA
There are two ways to figure out the ROA of a stock. One option requires the knowledge of the net profit margin, and the asset turnover. The other requires the net income and the average assets. In this real life example, I will use Johnson's Controls as an example. The first step is to calculate the net profit margin.
Divide the net income, 469,500,000 by the 18,427,200,000 the total revenue.
469,500,000/18,427,200,200 = 0.025 = 2.5%
I came up with 0.025 or about 2.5 percent. This is equal to the Net Profit Margin.
The Asset Turnover for one year is calculated by averaging the total assets from 2001 and 2000. (9,911,500,000+9,428,000,000)/2 = 9,669,750,000
and divide by the total revenue
9,669,750,000/18,427,200,000 = 1.90
I came up with 1.90. This is equal to the Asset turnover
We have both of the components of the equation to calculate return on assets:
.025 (net profit margin) x 1.90 (asset turn) = 0.0475, or 4.75% return on assets
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The second option for calculating ROA is much shorter.
Just divde the net income by the average assets
469,500,000/9,660,750,000 = 0.04859 = 4.85%
I came up with 4.85% as the ROA. You may wonder why the ROA is different depending on which of the two equations you used. The first, longer option came out to 4.75%, while the second was 4.85%. The difference is due to the imprecision of our calculation; we truncated the decimal places. For example, we came up with asset turns of 1.90 when in reality, the asset turns were 1.905654231. If you opt to use the first example, it is good practice to carry out the decimal as far as possible.
Is a 4.75% ROA good for Johnson Controls? A little research shows that the average ROA for Johnson’s industry is 1.5%. It appears Johnson’s management is doing a much better job than the competitors. This should be welcome news to investors.
The lower the profit per dollar of assets, the more asset-intensive a business is. The higher the profit per dollar of assets, the less asset-intensive a business is. All things being equal, the more asset-intensive a business, the more money must be reinvested into it to continue generating earnings. This is a bad thing. If a company has a ROA of 20%, it means that the company earned $0.20 for each $1 in assets. As a general rule, anything below 5% is very asset-heavy (manufacturing, railroads), anything above 20% is asset-light (advertising firms, software companies).
