Issue 86, 24 August 2001
Investor's College How to use ROA The importance of a high asset turnover in a business with low profit margins is clearly demonstrated by comparing Woolworths to the recently departed Agro Holdings which was placed in receivership in April. Although we've warned about comparing companies in different industries (Agro sold farm machinery) this illustration highlights the importance of asset turnover.
The difference is striking. Agro had a lower margin AND a lower asset turnover. Additionally, with an ROA lower than bank interest, shareholders' money would have been better off on term deposit. And much safer too. If a company's ROA is consistently low (i.e. less than you might get from a bank) it's generally a sign that shareholder value is being destroyed.
There's a faster way to calculate ROA. Simply divide the EBIT figure by total assets. Doing it the long way, though, gives you a better understanding of the economics of the business. You will also have two other ratios by which to judge the company and compare against others. Give preference to companies that consistently produce good returns on their assets and think twice before investing your money in companies that score poorly, like Agro.
C o p y r i g h t ÂŠ 2 0 0 6 The Intelligent Investor . Published by The Intelligent Investor Publishing Pty Ltd. ABN 12 108 915 233. Australian Financial Services Number 282288. PO Box 1158, Bondi Junction NSW 1355. Ph: 1800 620 414 Fax: (02) 9387 8674 WARNING This publication is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, seeking advice from a financial adviser or stockbroker if necessary. Not all investments are appropriate for all subscribers.
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