How to Calculate Return on Assets in Investment Banking

By Matt Krantz, Robert R. Johnson

When investors buy stock or debt issued by a company, they’re taking an investment banking leap of faith. The assumption is that the company is going to use the money to buy assets that can be used to drive higher profits, which can be paid to shareholders. But the type of assets bought can have a big influence on the returns shareholders ultimately get.

Let’s say a company needs to buy a fleet of cars for salespeople to deliver product. That’s reasonable. The company could do the prudent thing and buy moderately priced Ford vans. But a company may instead decide that it’s more fun for the salespeople to drive brand-new Ferrari sports cars. That would be more fun, but it would wreak havoc on the company’s return on assets (ROA).

Poor investments that don’t deliver the return are what investment bankers are looking for with the ROA calculation. The measure is calculated as:

image0.jpg

You already know how to get the company’s net income, to plug into the numerator. To get the denominator, the average total assets, you’ll have do to a bit of work. Add the value of the company’s assets at the end of the period you’re analyzing to the value of the assets at the beginning of the period and divide by 2.

Investment bankers know that the higher the ROA, the better the company is harvesting profit from the assets it has acquired and deployed. Imagine that the company with the fleet of vehicles hauls in $10 million in net income.

Now, the company using the low-cost Ford vehicles has assets of $100 million. That company’s ROA is 10 percent. But if the company instead opts for the Ferrari fleet, and has assets of $500 million, suddenly the ROA drops to a paltry 2 percent.

ROA can vary greatly based on the industry that the company is in. And for that reason, investment bankers pay close attention to industry analysis with ROA. But even so, investment bankers can use this ratio to pinpoint companies that are finding intelligent ways to extract profit from their assets, especially by comparing ROA from year to year.