Return on assets (ROA) is a financial statistic that shows how profitable a business is compared to its total assets. ROA is a metric that may be used by the general public and corporate management, analysts, and investors to measure how effectively a firm uses its assets to create profit. ROA can be easily calculated: Net Income / Total Assets
But which number is the best? It depends on the industry, but generally, the higher, the better. The best way to make a comparison is to download the data (ROA) of companies from the same sector. The reason is that they will have a very similar asset base.
The most significant limitation is that ROA cannot be utilized across industries. ROA is better suited for asset-heavy companies than asset-light ones. ROA in software companies or high-tech industries can significantly differ. Due to a low asset base (primarily long-term assets), ROA in the technology sector can be very high.
From this point of view, we would not use ROA as a strong determinator of profitability in the fintech industry (except banks), where Paypal is. On the other hand, Paypal’s ROA is 4.8%, which is unsatisfying among the competition. Visa got a solid 16% and MasterCard 26%. In this case, we would not focus too much on ROA in this sector. Or in other words, we would not give it such great importance here. The reason is a significant deviation in asset base among the companies in the selected industry.
We also took a screenshot of the Alibaba (BABA) results, even though the company is not in the same industry. From Alibaba’s sector (internet and direct marketing retail), the ROA is crucial for investors from a profitability point of view.
While 3.6% is not great in absolute terms, it can be great regarding sector comparison. We will stick the screen from the median/average comparison vs. Alibaba results at the end of the chapter. Now that we understand the significance of ROA and its limitations across industries, let me move on to another critical profitability indicator: ROE and its difference from ROA.