The ROA index is often mentioned in stock investment. So What is ROA index? What does it mean for investors and how to use ROA effectively in stocks.
What is ROA index?
The ROA index is an abbreviation of (Return On Assets) which is the rate of return on total assets of a business or company called ROA. Investors are often interested in ROA to check the company's profitability on the total assets of the company. This allows investors to evaluate whether the business is on the right track according to the plan and to make plans to make adjustments and develop appropriately for the company.
What is a good ROA ratio?
In the business sector, the size of the enterprise and the level of competition in the sector, the level of inflation index and other factors will be used to evaluate the financial profit index (ROA) of the enterprise. When the asset growth index (ROA) reaches the level of 5-10%, it is usually considered a good level, and shows that the company has used its assets reasonably and effectively.
In addition, how “good” the ROA ratio is will also depend on the industry and sector of a person or a specific business situation. The ROA ratio will provide a more accurate view of financial performance by comparing other businesses in the same industry.
The meaning of ROA for businesses and investors
For business
ROA is considered an index that businesses often use to evaluate and measure their operating efficiency. Normally, managers will determine the net profit index earned from the initial capital invested by using the ROA index. When the ROA index gives a "higher" result, it shows that the business is operating effectively and has a lot of potential for growth in the future.
For example: Company A earned 1 billion VND in profit in 2022 on total assets of 10 billion VND, so company A has ROA coefficient = 10%.
Companies can rely on the ROA index as a basis for considering making business decisions. To evaluate ROA, this index is often compared over time or with companies of the same size in the field. A high ROA index shows that the company's current development strategy is effective, while a low ROA index signals the need to change the business strategy.
For investors
ROA is an important financial indicator in business, the ROA index will help investors evaluate the profitability of a business in the stock market.
- The ROA index can evaluate the efficiency of a company's capital use. Specifically, it reflects how many dongs of revenue can be generated for every 10 dong of company assets.
- When ROA is high, it tells investors that the company is using its assets efficiently to generate good profits. Securities that are said to have high ROA are often more sought after and have higher values.
- When the ROA index is low, it shows that the company's resources are not being exploited effectively.
- However, there are some cases where the company operates well, but the ROA index is still low. The operating business will not need to invest in fixed assets and can still generate good profits. For example, in the consumer goods industry, or information technology. At this time, investors should consider other indexes such as ROE, P/E to be able to evaluate accurately.
- For companies that require a lot of capital to operate, such as heavy manufacturing industries. When using the ROA index for evaluation, investors should compare between companies in the same industry or can compare with the company's past ROA index.
- In an industry, a company with a higher ROA will exploit its assets better. If a company has an ROA that increases over time, this will show that the company's efficiency in exploiting its assets is improving.
Additionally, a company's return on assets (ROA) is a popular tool that most investors often use to assess whether a company is operating efficiently and has the potential to grow in the future.
What does the ROA index say?
ROA shows what percentage of profit a business is earning from its assets. To calculate ROA, we will take Net Profit divided by Total Assets and multiply by 100 to convert to a percentage.
ROA calculation formula
ROA = (Net profit or profit after tax/ total assets of the enterprise) * 100%
In there:
Net profit will be calculated by profit earned minus tax.
Total assets will include all the capital used by the company, including both equity and debt (total assets = equity + debt).
How to use ROA index in stocks effectively?
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Investors can understand clearly investment knowledge to evaluate a company using the ROA (or some other ratio) before deciding whether to invest in the company's stock. First, it is necessary to apply the ROA formula to consider the current asset value of the company. Then, it is necessary to review previous reports to determine the past asset value index.
To accurately evaluate the ROA index, it is necessary to rely on the following factors: The company's field of operation. Normally, the asset structure of companies operating in different fields will be different.
Companies in heavy industries (such as cement, concrete and steel) will typically have low ROA ratios because they will need a lot of fixed assets to have high value.
In the IT and service industries, there is no need for many fixed assets, so their ROA is usually higher.
To be able to make comments and assessments, investors should consider the company's ROA compared to similar companies in the same industry.
What are the advantages and disadvantages of ROA ratio?
Advantage
- Easy to calculate: Based on the financial report, you can calculate this indicator yourself.
- Helps compare businesses with each other: ROA can be used to compare the profits of businesses in the same industry and field.
- Provides deeper insight into performance: The ROA ratio lets you know how effectively a business is using its assets to generate profits.
- Measures overall profitability: The ROA ratio takes into account a company's revenue and expenses, providing a more comprehensive measure of profitability.
However, the ROA index is not the "ultimate" index, it can only reflect one aspect of the company, it cannot cover the whole financial picture.
Disadvantages
- ROA is not 100% accurate, it only reflects certain aspects of the company and cannot cover the entire financial situation. When deciding to invest, you should combine other indicators to be sure.
- The ROA is nothing compared to other companies in the industry. However, for some heavy industrial sectors, this ratio must be above 10% to be considered good.
- A company's profitability fluctuates. Therefore, a short-term ROA will not be effective.
- Profitability is an indicator that a business can apply accounting methods to trim or exaggerate for the benefit of the company. Therefore, the ROA index can be distorted.
Notes before using ROA
ROA has the same limitations as other ratios. ROA is not suitable for comparing companies of different sizes or in different industries. Each industry has its own characteristics. For example, retail companies will typically have lower profit margins than service companies and lower return on assets (ROA).
A company's return on assets (ROA) can vary greatly depending on its stage of life cycle, even for businesses in the same industry and of the same size. A company in the investment or growth stage will typically have a lower ROA.
Therefore, return on assets (ROA) is often best used to analyze a business's asset investment efficiency over time, such as tracking it on a quarterly or annual basis.
Combining ROA and ROE analysis
Analyzing between ROA and ROE will help us have a comprehensive view of a company's performance and profitability.
ROE index (Return on Equity): This is considered an index measuring the ability to generate profits from equity. The ROE index shows how much profit a company generates from each dollar of shareholder capital.
You can calculate the ROE index based on the following formula:
ROE = (Profit after tax / Equity) * 100
In there:
- A company's net profit after tax means its net profit after deducting all relevant expenses.
- A company's equity is the capital the company itself invests (excluding borrowed capital).
For example: The company has a profit after tax of 50 billion and equity of 150 billion. Then the ROE index = (50/150)×100 = 33%
Meaning of ROE
Return on equity (ROE) allows investors or managers to assess how much of a company's capital invested in operations can generate net profits. A higher ROE indicates that the company is using its capital more efficiently.
Currently, the relationship between ROA and ROE indexes is clearly shown through the following formula:
Financial leverage ratio = ROE / ROA = Total current assets / Owner's equity
This is a formula that helps business managers evaluate the efficiency of capital use in their businesses. The company's ability to use capital will increase if the financial leverage is low and vice versa. To maintain operations, companies with high financial leverage often have to seek external sources of capital. Therefore, companies are now focusing more on increasing the ROE index, which will help companies operate more efficiently and stably.
Conclude
All the above content, HVA Group has compiled all the information to answer the question What is ROA index?? and the calculation formulas, advantages and disadvantages and the significance of the ROA index for each company. Understanding the importance of the ROA index in measuring and evaluating operational performance, companies need to take a closer look at this index continuously for many consecutive years to have appropriate assessments and adjustments.
