Return on Assets – ROA Definition

Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA gives a manager, investor, or analyst an idea as to how efficient a company's management is at using its assets to generate earnings. Return on assets is displayed as a percentage.

$Return\ on\ Assets = \frac{Net\ Income}{Total\ Assets}$Return on Assets=Total AssetsNet Income​

Return on assets (ROA) is calculated by dividing a company’s net income by total assets.

Return on assets (ROA), in basic terms, tells you what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry. This is why when using ROA as a comparative measure, it is best to compare it against a company's previous ROA numbers or against a similar company's ROA.

The ROA figure gives investors an idea of how effective the company is in converting the money it invests into net income. The higher the ROA number, the better, because the company is earning more money on less investment.

Remember total assets is also the sum of its total liabilities and shareholder's equity. Both of these types of financing are used to fund the operations of the company. Since a company's assets are either funded by debt or equity, some analysts and investors disregard the cost of acquiring the asset by adding back interest expense in the formula for ROA.

In other words, the impact of taking more debt is negated by adding back the cost of borrowing to the net income and using the average assets in a given period as the denominator. Interest expense is added because the net income amount on the income statement excludes interest expense.

ROA is most useful for comparing companies in the same industry, as different industries use assets differently. For example, the ROA for service-oriented firms, such as banks, will be significantly higher than the ROA for capital intensive companies, such as construction or utility companies.

Let's evaluate the return on assets (ROA) for three companies in the retail industry:

• Macy's (NYSE: M)
• Kohl’s (NYSE: KSS)
• Dillard's (NYSE: DDS)

The data in the table is for the trailing twelve months as of Feb. 13, 2019.

Due to the increasing popularity of e-commerce, brick and mortar retail companies have taken a hit in the level of profits they generate using their available assets. Still, every dollar that Macy's has invested in assets generates 8.3 cents of net income. Macy's is better at converting its investment into profits, compared with Kohl’s and Dillard’s. One of management's most important jobs is to make wise choices in allocating its resources, and it appears Macy’s management is more adept than its two peers.

Both ROA and return on equity (ROE) are measures of how a company utilizes its resources. Essentially, ROE only measures the return on a company’s equity, leaving out the liabilities. Thus, ROA accounts for a company’s debt and ROE does not. The more leverage and debt a company takes on, the higher ROE will be relative to ROA.

The biggest issue with return on assets (ROA) is that it can't be used across industries. That’s because companies in one industry—such as the technology industry—and another industry like oil drillers will have different asset bases.

For related insight, read more about how to use ROA to gauge a company’s profits.