5. Return on Assets (ROA)

In contrast, Return on assets (ROA) measures the company's profitability relative to its total assets (liabilities and equity). The earnings figure should therefore capture the profits the firm generates for all the providers of capital (debt and equity holders). Put differently, the earnings figure should be free of financing effects.  

Two earnings figures are commonly used to compute ROA: 

  • EBIT and the so-called 
  • Net Operating Profit Less Adjusted Taxes (NOPLAT).

We have discussed both earnings measures in the section "Understanding Financial Statements."

 

As we have seen, NOPLAT reflects the firm's net income from operating activities. Therefore, our ROA definition of choice is:

 

\( ROA_{NOPLAT} = \frac{NOPLAT}{\text{Average book assets}} \).

 

Alternatively, some analysts express ROA relative to the firm's "operating income", as measured by earnings before interest and taxes (EBIT):

 

\( ROA_{EBIT} = \frac{EBIT}{\text{Average book assets}} \).

  

Finally, it is also fairly popular to use the firm's net income to measure ROA:

  

\( ROA_{\text{Net income}}= \frac{\text{Net income}}{\text{Average book assets}} \).

 

However, as we have just mentioned, net income reflects the earnings generated for the shareholders whereas total assets captures the claims of both shareholders and debtholders. Therefore, the former is affected by the firm's financing structure whereas the latter is not (that much). This is why we should be cautios when measuring ROA based on net income. 

Given that different analysts express ROA in different ways, it is important to first check how ROA was measured before making comparisons across companies.

 

Let us now compute the ROA of Hershey. We have collected the following information from the balance sheets and income statement  (in millions of USD):

  • EBIT in 2015: 1'037.8
  • NOPLAT in 2015: 590.2
  • Net income in 2015: 513.0
  • Average assets in 2015: 5'483.6

  

With this information, we can compute the three ROA measures discussed above:

   

\( ROA_{NOPLAT} = \frac{NOPLAT}{\text{Average book assets}} = \frac{590.2}{5'483.6} \) = 18.9%.

 

\( ROA_{EBIT} = \frac{EBIT}{\text{Average book assets}} = \frac{1'037.8}{5'483.6} \) = 10.8%.

  

\( ROA_{\text{Net income}}= \frac{\text{Net income}}{\text{Average book assets}} = \frac{513.0}{5'483.6} \) = 9.4%.