Return on Assets

Examples of Return on Assets in the following topics:

• Relationships between ROA, ROE, and Growth

  • Return on assets is a component of return on equity, both of which can be used to calculate a company's rate of growth.
  • Return on assets is equal to net income divided by total assets.
  • In other words, return on assets makes up two-thirds of the DuPont equation measuring return on equity.
  • Return on assets is equal to net income divided by total assets.
  • Discuss the different uses of the Return on Assets and Return on Assets ratios

• Return on Total Assets

  • The return on assets ratio (ROA) measures how effectively assets are being used for generating profit.
  • The return on assets ratio (ROA) is found by dividing net income by total assets.
  • It is also a measure of how much the company relies on assets to generate profit.
  • Second, the total assets are based on the carrying value of the assets, not the market value.
  • The return on assets ratio is net income divided by total assets.

• The Capital Asset Pricing Model

  • The capital asset pricing model helps investors assess the required rate of return on a given asset by measuring sensitivity to risk.
  • All this really means is that investors are on the look out for ways to minimize risk, maximize returns, and invest intelligently in assets that are well-priced.
  • When measuring the ratio between risk and return on a given investment, the capital asset pricing model (CAPM) can be a useful tool.
  • This model focuses on measuring a given asset's sensitivity to systematic risk (also referred to as market risk) in relation to the expected return compared to that of a theoretical risk-free asset.
  • On the right side, you have the overall return (similarly relative to a risk-free asset).

• The DuPont Equation

  • The DuPont equation is an expression which breaks return on equity down into three parts: profit margin, asset turnover, and leverage.
  • Using DuPont analysis, what is the company's return on equity?
  • Under DuPont analysis, return on equity is equal to the profit margin multiplied by asset turnover multiplied by financial leverage.
  • Similar to profit margin, if asset turnover increases, a company will generate more sales per asset owned, once again resulting in a higher overall return on equity.
  • As was the case with asset turnover and profit margin, Increased financial leverage will also lead to an increase in return on equity.

• The SML Approach

  • Expected return = 5% + 1.9*(12% - 5%) Expected return = 18.3% We expect the asset to return 18.3% and be plotted on the SML.
  • However, the current real rate of return for the asset is 19%.
  • Individual assets that are correctly priced are plotted on the SML.
  • In the ideal world of CAPM, all assets are correctly priced and thus lie on the SML.
  • Conversely, an asset priced below the SML is overvalued, since for a given amount of risk, it yields a lower return.

• Calculating Expected Portfolio Returns

  • A portfolio's expected return is the sum of the weighted average of each asset's expected return.
  • Let's say that we have a portfolio that consists of three assets, and we'll call them Apples, Bananas, and Cherries.
  • The return of our fruit portfolio could be modeled as a sum of the weighted average of each fruit's expected return.
  • W is weight and E(RX) is the expected return of X.
  • A math-heavy formula for calculating the expected return on a portfolio, Q, of n assets would be:

• Expected Risk and Risk Premium

  • The notion of risk implies that a choice having an influence on the outcome exists.
  • This type of risk is uncorrelated with broad market returns, and with proper grouping of assets can be reduced or even eliminated.
  • The term risk premium refers to the amount by which an asset's expected rate of return exceeds the risk free rate.
  • The difference between the return of an asset in question and that of a risk-free asset -- for instance, a US Treasury bill -- can be interpreted as a measure of the excess return required by an investor on the risky asset.
  • Beta is a measure that relates the rate of return of an asset, ra, with the rate of return of a benchmark, rb.

• Implications for Expected Returns

  • Asset allocation is the theory that any portfolio should have a set of target weights for different asset classes based on time frame and risk tolerance.
  • Look at how the different asset mixes fare, based on a 10-year period that is consistent with historical averages.
  • The theory can feature different strategies, including strategic asset allocation, tactical asset allocation, and others, but the ideas are the same as the implications for return.
  • A portfolio should consist of a variety of classes of assets to take advantage of zero and negative correlations between those classes, and it should be designed to achieve a target mix of assets that are rebalanced when one grows in relation to another.
  • Different returns are expected for different asset allocations given historical averages

• Components of the Balance Sheet

  • The balance sheet relationship is expressed as; Assets = Liabilities + Equity.
  • The balance sheet contains statements of assets, liabilities, and shareholders' equity.
  • A business incurs many of its liabilities by purchasing items on credit to fund the business operations.
  • A company's equity represents retained earnings and funds contributed by its owners or shareholders (capital), who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment.
  • Generally, sales growth, whether rapid or slow, dictates a larger asset base - higher levels of inventory, receivables, and fixed assets (plant, property, and equipment).

• Assets

  • Assets on a balance sheet are classified into current assets and non-current assets.
  • Assets are on the left side of a balance sheet.
  • On the left side of a balance sheet, assets will typically be classified into current assets and non-current (long-term) assets.
  • A current asset on the balance sheet is an asset which can either be converted to cash or used to pay current liabilities within 12 months.
  • The investor keeps such equities as an asset on the balance sheet.