ROA, ROE, ROC – Hints for Investors and Marketers from Financial Ratio Analysis

On the whole, measuring returns in business is critical and ROA, ROE, ROC ratios is a super useful way to monitor whether a company is putting money entrusted to it to good use. Moreover, these three metrics can provide investors and marketers a picture of the company’s potential investment evaluation, although it needs to be cautious to look into.

In this article, I will go through ROA, ROE, ROC financial analysis ratios and share tips to look into them to gain insightful opportunities for investors and marketers, and also avoid data traps.

roa, roe, roc

On the whole, measuring returns in business is critical and ROA, ROE, ROC ratios is a super useful way to monitor whether a company is putting money entrusted to it to good use. Moreover, these three metrics can provide investors and marketers a picture of the company’s potential investment evaluation, although it needs to be cautious to look into.

In this article, I will go through ROA, ROE, ROC financial analysis ratios and share tips to look into them to gain insightful opportunities for investors and marketers, and also avoid data traps.

For whom

  • Investors and Marketers

ROA ROE ROC – Table of Content

Why ROA, ROE, ROC is critical?

These three metrics, which are ROA, ROE, ROC, basically monitor the returns of the operational business of the entire business. It’s a kind of big picture of a company’s performance for external parties, including investors and marketers.

Metrics are examples of how insights can be gleaned by comparing data from two separate financial statements, which are income statement and balance sheet. Such cross-financial statement analysis can be very insightful when putting a company’s profit into context.

Return on Asset or ROA

When considering a stock or a bond issued by a company, we presume that the company is using those investor’s money to buy assets or implement capital investment that can drive much earnings, which shareholders at the end can benefit from. Nonetheless, the fact is that the type of assets bought can have a big influence ultimately on the returns.

roa, roe, roc

Thus, here is why ROA can give us some hints. Return on assets, or ROA, is a profitability ratio that determines a company’s profitability relative to its assets. The percentage it provides illustrates how much profit a company generates for each dollar of assets invested in the business. Here is the equation as follows:

ROA = Net Income / (End of analysis period of total asset + Beginning of analysis period of total asset) / 2

Basically, a company, which can have a higher ROA, indicates that the company can gain better profit from the asset it has acquired and deployed

However, companies are adept at manipulating the figures, which implies they might extract some data from the total amount of assets to increase the ROA performance.

Total amount of asset is consisted of several standard variables as follows:

  • Cash & cash equivalent
  • Short term and long term capital investment
  • Account receivables
  • Inventory
  • PPE (Property plant equipment)
  • Intangible and goodwill asset
  • Tax asset
  • Current and non-current asset

Hints for Investors and Marketers

For investors, I suggest looking into the trend of a company’s ROA and don’t just buy those with higher ROA. Instead, please ask why they have a higher ROA. Be sure to break down what variable drives the growth of a company’s ROA. It’s because most of the time some companies like to manipulate numbers to hook investors, such as extracting cash or cash equivalent, in order to appeal investment.

Meanwhile, comparable company common-sizing analysis is a must because looking into an industry and comparing with other competitors’ ROA can justify the fact. Since a standalone high ROA doesn’t imply anything, It’s more accurate to analyze in a horizontal view.

For marketers,  I suggest referring to those symbols with a higher ROA or an upward momentum of growth, and look at what variables boost it, such as higher net income, or less account receivables, inventory stock etc. By learning the listed companies’ approach, It’s helpful to optimize the ROA in your business, and appeal to more investors through adjusting marketing and PR strategies and execution plans.

Return on Equity or ROE

Return on equity (ROE) measures the profitability of a corporation in relation to its total amount of shareholder equity. Essentially, the ratio is a way to see how well management is making use of the money invested by the shareholders.

ROE = Net Income / Shareholders's Total Equity

roa, roe, rocShareholder’s total equity is equal to total asset minus total debt. Thus, to some extent, higher ROE doesn’t represent a better return and efficiency handled by the management. It’s because the company might increase financial leverage of debt when both net income and total assets hover over a certain same level.

Although ROE becomes higher by leveraging more debt, it also increases the cost of debt and adds more uncertainties. So be sure to carefully look into the reasons. If it’s owing to higher net income, definitely it’s good news.

Hints for Investors and Marketers

For investors, apart from common-sizing comparable analysis, be sure to check if the company pays dividends. Since retained earnings are added to the paid-in capital to calculate the total shareholder equity, dividend payments will reduce the total shareholder equity on the balance sheet. Above all, a lower ROE might be good in a way because it has just diluted by the dividends.

For marketers, I suggest referring to those listed companies with higher ROE although debt/equity ratio is also high. Marketers can think of strategies to increase and optimize assets through marketing activities. Except for boosting sales,  intangible assets such as brands, IP, trademark, copyrights, patents etc, is a key driver. Particularly, Web3.0 facilitates intangible assets to be priced and traded as well. Thus, marketers should leverage Web3.0 technology and practices to deploy for the business and execute plans.

Return on Capital or ROC (Or Return on Invested Capital or ROIC)

Return on Invested Capital (ROIC) or we call return on capital ROCis a profitability or performance measure of the return earned by those who provide capital, namely the firm’s bondholders and stockholders. It’s an extremely important financial ratio to investors.

It’s an extremely important financial ratio to investors because of comparing a firm’s return on invested capital to its weighted average cost of capital (WACC) to see whether the company creates or destroys value.

Return on Capital = Tax-adjusted EBIT / (End of analysis period of total capital invested + Beginning of analysis period of total capital invested) / 2

In terms of capital invested, here are a list of capital as follows:

  • Total equity
  • Cost of debt, such as interest
  • Long term and short term debt

If the ROC is greater than the WACC, then value is being created as the firm invests in profitable projects. Conversely, if the ROC is lower than the WACC, then value is being destroyed as the firm earns a return on its projects that is lower than the cost of funding the projects.

Hints for Investors and Marketers

For investors, I suggest referring to ROC as a main metric. It’s because A firm being able to consistently earn an ROIC greater than its WACC is an indicator of a strong economic moat and of the firm’s ability to sustain its competitive advantage. In a way, it reflects the cost of debt and cost of equity sit at a lower position. This signal both is kind of bullish information for a long-term investment on this company.

For marketers, be sure to draw up a list of symbols which ROC is greater than WACC. That implies that these companies might have more room to invest on initiating marketing campaign innovations that try new ideas to communicate with audiences. It’s a good source to find inspirational showcases.

On the other hand, boosting a higher ROC has only one way out for marketers, which is to boost sales.

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Compared to ROA and ROE, ROC has less room to be manipulated because it’s used to compared with WACC which is the cost of capital in the market by nature.

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