Alert Message
Quarterly return on assets down significantly.
Alert Definition
A company’s return on assets usually doesn't collapse overnight, so the decrease of at least 20% signaled by this alert means this bad news has been brewing for a while. Return on assets (ROA in financial shorthand) measures how much a company earns on each dollar sunk into assets. It’s calculated by dividing total assets into net income for the period. Assets are listed on the company’s balance sheet and include such items as inventory, and plant and equipment. The number tells investors how productively a company and its management are using the physical resources that the company owns -- the higher the ROA, the more efficient the operation.ROA is a particularly effective way of measuring the efficiency of manufacturing companies, but it doesn't always work so well in the service industry, or for companies in which the primary assets are people instead of equipment. To get the most insight out of return on assets you should look at the number in two different ways:
-- Look at the trend in return on assets over time. A falling return on assets could indicate that the company’s customers find new products much less valuable than an existing product line or much less valuable than competitor’s offerings and aren’t willing to pay as much for them. Older products with lower margins could be making up a bigger and bigger part of sales. An older factory simply can’t produce the company’s products very efficiently anymore. Management can simply be clueless about how to control expenses. A falling return on assets inevitably leads to a declining stock price as investors realize that management is earning less and less profit on the things the business owns.
-- Compare a company’s return on assets with the ratio at other companies in its industry. Companies with a high return on assets relative to their peers own a very powerful weapon. They are getting more profit out of each dollar of machinery or inventory, for example. That means they have more money to devote to marketing or research and such companies certainly have an easier time attracting investment capital for new factories and new products. Companies with a low return on assets are probably losing ground to competitors. A steadily falling return on assets may be a sign that this company is headed onto history’s trash heap. Of course, this is exactly the kind of company that the turnaround, value investor wants. This ratio can be very useful in helping to identify companies with underperforming assets that could make more money under new management. A word of caution: Cyclical industries such as airlines, automobiles and chemicals will show a falling return on assets as they slide from the most profitable part of their cycle towards the red ink that characterizes a bottom. Comparing return on assets across an industry will still work for cyclical companies as long as they are at approximately the same point in the industry cycle.
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