One way to evaluate a stock is to look at how effective the company’s management is in utilizing the resources available to them.
This measure of management effectiveness provides you with an idea of how well the company is being run relative to others in its sector and the market as a whole. Consistently low numbers are a red flag.
Unlike many comparisons, you can use these ratios to compare companies in different industries. The ratio's are:
Return on assets
Return on investment
Return on equity
Fortunately, you don’t have to compute these ratios yourself. Many websites provide this information.
Return on Assets
Return on assets tells you how well a company’s management uses its assets to make a profit.
You calculate the ROA by taking the net income and dividing it by the total assets. The ROA comparison works better over time so you can see a trend in how well management uses assets to the advantage of the company.
The higher the ratio, the better and the continued high level over time is even better because it indicates management makes a habit of managing with efficiency.
Poorly managed companies, will consistently fall before industry averages in this area, while better run companies stay out in front of the averages.
Return on Investment
Return on investment measures not only the company’s contribution, but also the purposeful use of leverage or debt to extend company’s reach.
You calculate ROI by dividing net profits by long-term debt plus other long-term liabilities plus equity.
Managers choose to combine the company’s equity with outside debt to extend programs quickly and efficiently.
Skillful use of debt can change a 50 million project into a 75 million project. If everyone has done their homework correctly, the company can see additional profit from a larger project than they could have afforded without the debt.
Return on Equity
If numbers are good, return on equity is like a music for stockholders ears. It measures how well management did in earning money for them.
Unlike return on assets and return on investment, this measure goes directly to the stockholders and their stake in the company.
Unfortunately, ROE is somewhat flawed. You calculate ROE by taking net income and dividing by shareholders equity. Missing from this equation is debt and that distorts the picture somewhat.
Although ROE is somewhat helpful in looking at companies, it doesn’t provide the guidance the ROA does.
Remember, look at the whole picture and not just a few numbers. Return on investment and return on assets are helpful in spotting quality management. Return on equity is less so, but still worth a look.
Disclaimer: The articles published in www.saralgyan.in is for the personal information of the authorised recipient and is not for public distribution and should not be reproduced or redistributed without prior permission.
The information provided in the website is from publicly available data and other sources, which we believe, are reliable. Efforts are made to try and ensure accuracy of data however, Saral Gyan Capital Services shall not be liable for loss or damage that may arise from use of the published posts/comments in the website. The published articles are purely for information purposes and does not construe to be investment recommendation/advice or an offer or solicitation of an offer to buy/sell any securities. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice.
Investors should not solely rely on the information contained in the website and must make investment decisions based on their own investment objectives, risk profile and financial position. The recipients of this material should take their own professional advice before acting on this information.