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.
The first quintile includes the companies that had
the lowest ROA and the 5th quintile includes the companies that had the highest ROA.
Not exact matches
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The same principle applies in reverse, however, making these leveraged buyouts potentially very risky; if the acquired company's
ROA is
lower than the cost of the debt used to buy it, then the private equity fund's ROE is less than if hadn't used debt.
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.
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.
The
lowest 20 percent of stocks ranked by
ROA are placed in the first quintile and the next 20 percent in the second quintile and so forth until we have five portfolios of stocks.
A reader noted that in his experience, higher
ROA actually seems to lead to
lower alpha in bactest.
It also found that the effects of activist activities improved long term operational performance at target firms, demonstrated by ROE and
ROA increases, while evidence of positive financial and corporate governance effects were observed in the form of increased dividend payouts and
lowered CEO compensation.