Always select companies with
high ROA to invest.
The first quintile includes the companies that had the lowest ROA and the 5th quintile includes the companies that had
the highest ROA.
Two competitors with identically low profit margins might have vastly different profitability because one grocer might be producing much
higher ROA due to its ability to turn its inventory over faster.
A reader noted that in his experience,
higher ROA actually seems to lead to lower alpha in bactest.
A company with
higher ROA is better for investment as it means that the company's management is efficient in using its assets to generate earnings.
Not exact matches
Obviously, Baseline screens are interesting, as are American Banker's lists of banks with
high ROEs or
ROAs.
The debt used in buyouts has a relatively fixed cost, so if a private equity fund's return on assets (
ROA) is greater than this cost, the fund's return on equity (ROE) is
higher than if it hadn't borrowed money.
As an aside, M. R. Greenberg was known to be adamant about his ROE goal (15 % after - tax on average equity), but he also liked the company to have bulk (
high assets — he liked asset - sensitive lines), which is why the
ROA slid in the latter part of his tenure.
Now, my stylized history of AIG takes it through the glory days of the 1980s, where return on assets [
ROAs] was
high, and financial leverage low.
I also noticed that companies with average, or in this case median
ROA, likely outperform stocks that have either
higher or lower returns on assets.
The second through fifth quintiles have
higher than average annual excess returns but the excess returns do not increase consistently as
ROA increases.
This is the same basic math that you'd see if you compare two companies with a 10 % net margin, but Company A turns over its assets twice as fast as company B, then Company A's
ROA will be twice as
high.
If your business begins to turn over its assets more slowly (i.e. it begins to generate less revenue per $ 1 of assets), then you'll need to make up for that by earning a
higher profit margin on each $ 1 of revenue if you are to maintain the same
ROA.
4) Note to the new management of AIG: please do the following: a) locate lines of business with low
ROAs and significant borrowing for funding in order to achieve
high ROEs.
Though capital allocation decisions are not captured perfectly in any one metric, many books argue that businesses that consistently achieve a
high return on capital measured as either
ROA, ROE, ROIC are more likely to display a history of good capital allocation decisions; particularly important is it that one's return on capital is consistently
higher than one's cost of capital (WACC), cf. Find the Best Stocks for further information.
Now, if
ROA is going up you really do not need the same amount of capital in the business itself, which means that dividend payout ratios can go much
higher than people think.