ROA and ROE are two basic metrics commonly used to evaluate the operational performance of a business.
ROA
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ROA - Return on total assets (ROA) is a measure of a company's profitability per dollar of assets.
Formula: ROA = Net profit for common shareholders/Total assets
ROA provides investors with information about the profits generated from the amount of capital invested (or the amount of assets). ROA for joint stock companies varies greatly and depends on the industry. That's why when using ROA to compare companies, it's always better to compare each company's ROA over the years and across similar companies.
A company's assets are made up of borrowed capital and equity. Both of these sources of capital are used to finance the operations of the company. The efficiency of converting invested capital into profit is shown by ROA. The higher the ROA, the better because the company is making more money on less investment.
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For example, if company A has a net income of VND 10 billion and total assets of VND 50 billion, then the ROA ratio is 20%. However, if company B also has the same income on total assets of VND 100 billion, B's ROA will be 10%. Thus, with the same profit of 10 billion dong, but company A is more efficient.
Investors should also pay attention to the interest rate the company pays on its debt. If a company doesn't earn more than it spends on investing activities, that's not a good sign. Conversely, if the ROA is better than the cost of borrowing, it means that the company is making good use of financial leverage.
ROE
ROE - return on common equity (Return on common equity), is the most important ratio for shareholders, measuring the profitability per dollar of capital of common shareholders.
Formula: ROE = Net profit for common stockholders/Common equity
This index is an accurate measure to evaluate a dollar spent and how much profit accumulated. This coefficient is often analyzed by investors to compare with stocks of the same industry in the market, thereby referencing when deciding which company to buy shares.
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The higher the ROE ratio, the more effective the company's management is in using the shareholders' capital, so it is often an important criterion for considering a company's stock investment opportunities.
The assessment of what is a reasonable ROE ratio will vary from industry to business. For example, with the Vietnamese stock market, the average ROE of industrial service enterprises is about 8.5%, construction and construction material suppliers have ROE of 11.6%, while , retail businesses have a significantly higher ROE ratio, at 25.6%. This difference depends on how capital intensive the business is to generate profits.
A general rule of thumb when evaluating businesses is to aim for companies with ROEs equal to or above the industry average. For example, company A has maintained a steady ROE of 18% over the past few years compared to the industry average of 15%. Investors may conclude that A's management has effectively used shareholder capital to generate above-average returns.
When calculating this ratio, investors can evaluate in specific angles as follows:
– ROE is less than or equal to bank loan interest, so if the company has a bank loan equal to or higher than shareholder equity, the profit generated is only to pay interest on bank loan.
If ROE is higher than bank interest rate, it is necessary to evaluate whether the company has borrowed from a bank and fully exploited its competitive advantages in the market to be able to assess whether this company can increase its ROE ratio in the future or not. .
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