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Return on Assets (ROA): Meaning, Calculations, and Excel Examples

Return on Assets (ROA) equals a company’s Net Income in a period, such as 1 year, divided by its average Total Assets over that same period; it measures a company’s efficiency in generating after-tax profits based on its Balance Sheet.

Return on Assets (ROA) Definition: Return on Assets (ROA) equals a company’s Net Income in a period, such as 1 year, divided by its average Total Assets over that same period; it measures a company’s efficiency in generating after-tax profits based on its Balance Sheet.

Return on Assets measures how efficiently a company uses its Total Assets to generate after-tax profits.

In other words, if two companies each have $500 million in Total Assets, including items such as factories and inventory, which one generates higher profits on those assets?

Companies that do this more efficiently have higher ROAs and should, therefore, be valued more highly.

Many online sources give examples of ROA for “standard” companies, such as retail and manufacturing companies, but in real life, ROA is primarily a metric for financial institutions, such as commercial banks and insurance firms.

That’s because these firms make money directly from the Total Assets on their Balance Sheet, while the link is indirect or nonexistent in other industries.

Files & Resources:

Return on Assets (ROA) – Presentation Slides (PDF)

Return on Assets (ROA) for Target, Costco, JP Morgan, and Citi (XL)

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Video Table of Contents:

0:00: Introduction

0:50: The Short Answer

3:05: Part 1: ROA Calculations for Target and Costco

6:32: Part 2: ROA for Banks (JPM, Citi, Wells, and BofA)

9:49: Part 3: ROA in Real-Life Financial Models

10:46: Recap and Summary

Return on Assets (ROA): Example Calculation and Benchmarking for Retailers

To demonstrate the ROA calculation, let’s look at two U.S.-based retailers: Target and Costco, both of which have revenue over $100 billion (with Costco over $200 billion).

Here’s the ROA calculation for each one over several years:

Return on Assets (ROA) Calculation

Return on Assets (ROA) Comparison

The key point is that the average ROA in this period is not much different. Yes, Costco is a bit higher in the most recent years (9-10%), but the “average” range for both companies is 8-10%.

Costco has lower gross margins and EBITDA margins, meaning it earns less in profits for each $1.00 in sales, but it also has higher expected growth rates (~5% rather than ~3%).

Based on these results, we might expect Costco to trade at slightly higher valuation multiples.

In reality, though, Costco trades at far higher valuation multiples than Target:

Return on Assets (ROA) and Valuation Impact

Given that these companies have similar growth rates, financial stats, and ROA figures, this is highly unusual and could indicate that Costco is greatly overvalued currently.

ROA is not the sole clue this is the case, but it is one of many factors we can look at.

Reviewing the comparable public companies tells a similar story:

Costco - Public Comps, ROA, and Valuation Multiple Comparison

Since Costco’s growth rates, margins, and ROA are all similar to those of the public comps, its valuation multiples seem incredibly high.

Return on Assets (ROA) for Commercial Banks and Why It Matters

This example above is a bit contrived because ROA is not that important for most companies in industries like consumer retail.

Many other factors, such as their employees’ performance, relationships with suppliers, and sales & marketing efforts, also affect their Net Income.

Asset efficiency plays a role, but it’s less of a direct link than some people claim.

Return on Assets is far more significant in the financial sector (i.e., Financial Institutions Groups (FIG) at banks) because many of these companies generate revenue and profits directly based on their Balance Sheets.

For example, the major drivers for commercial banks are Loans and Deposits.

A bank lends money to customers who need to borrow, and on the other side of its Balance Sheet (Liabilities & Equity), it creates Deposits to match these Loans.

But a bank can’t do this indefinitely; it must also maintain a certain amount of regulatory capital in case too many of its Loans default, resulting in unexpected losses.

Bank regulatory capital is, basically, Common Shareholders’ Equity with some adjustments (see our detailed tutorial on bank regulatory capital here).

Since a bank’s Loans represent over 50% of its Total Assets, and since it earns money directly from the Interest Income on these Loans:

-Loans and Total Assets are the key drivers in all bank models.

-Return on Assets (ROA) is critical because a bank using its Total Assets more efficiently will generate higher Net Income.

-And the more Net Income the bank generates, the more “regulatory capital” (Shareholders’ Equity) it will need to support its Loan Growth.

Return on Assets (ROA) for Commercial Banks: Benchmarking

Here’s an example of the ROA calculation and the bank-specific valuation multiples (P / E and P / BV) for two large, money-center banks (JP Morgan and Citi):

Return on Assets (ROA) for Commercial Banks

JP Morgan’s ROA is in the 1.0 – 1.5% range, while Citi’s is in the 0.5 – 1.0% range, and this difference has existed for many years.

Its margins and growth prospects are also better, so it is no surprise that it trades at a higher P / BV (Price to Book Value) multiple.

It is a bit unusual that the P / E multiples for these two banks are similar despite the ROA and growth rate differences, but there may be explanations for that, such as non-recurring expenses, Gains / Losses, or acquisitions / divestitures.

Again, ROA is not the only factor that explains the valuation differences.

You also look at metrics such as the Return on Equity (ROE), Loan Growth, the Net Interest Margin (NIM), and more.

However, if all these metrics, including ROA, are higher for one bank, this bank “should” be valued more highly in the market (assuming it’s similar in terms of size and geography to all the other banks in your set of comparable companies).

If it’s not valued more highly than similar banks with lower ROA and ROE figures, you may have found an undervalued bank.

Here’s a graph illustrating the close relationship between ROA and P / BV multiples for commercial banks, based on the 4 biggest U.S. banks:

Return on Assets (ROA) vs. P / BV Multiples for Commercial Banks

Return on Assets (ROA) in Real-Life Financial Models

In financial models, such as 3-statement models and DCF models, ROA is rarely a direct driver.

Instead, it’s more of an “informational metric” that you can use to answer questions such as:

-Do your assumptions translate into higher efficiency for the company you are modeling?

-Does that higher efficiency also correlate with higher valuation multiples?

-What revenue growth and margins are required for a company to achieve an ROA of X%?

Even in commercial bank valuations and dividend discount models, ROA is used to cross-check your work rather than a direct input.

If you understand that, you’ll be ahead of the game with Return on Assets in all contexts.

About Brian DeChesare

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.