Return on Total Assets (ROTA) is one of the key metrics of a firm’s operating performance. The ratio takes into account the assets that the company uses to support its core operations and compares them to the net income that it generates by using these assets.
Hence, a high ROTA ratio implies that the company can generate a sufficient return on these assets without needing a big reinvestment. In other words, they are more capital efficient.
Editor’s Note: This is a guest contribution by Christina Pomoni. Updated 6/9/22.
The Warren Buffett Way
Warren Buffett is a globally known investment guru with a fantastic ability to spot great investment ideas and generate a profit. Although what he does sounds far too complicated, the truth of the matter is that Warren Buffett likes to keep things simple.
For example, one of his best quotes related to long-term investing is:
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”
Some people might say “easier said than done”, but Buffett’s way is based upon fundamental relative valuation.
Buffett says Stock X is a buy, or if you already own Stock X, you should hold it. How does Buffett reach this decision? Definitely not by speculating. Instead, he likely looks at financial or valuation metrics; one easy one for us to learn is ROA.
First of all, Buffett is a value investor, hence, he is favoring long-term investing, and he is looking for undervalued stocks. He determines a company’s intrinsic value and he looks to find a margin of safety in the price he pays for that company’s stock.
Buffett seems to follow companies that consistently deliver a high ROA ratio, suggesting that, in the long-run, these companies can compound capital at a superior rate.
Understanding the ROTA Formula
ROTA = ROA = Net income / Total Assets
So, for simplicity, we assume that a company has a net income of $2.5 million and total assets of $6.8 million, hence its ROA is $2.5 / $6.8 = 36.76%.
What does the 36.76% mean? That for every dollar the company invests in its assets, it generates almost $37 dollars in profits. Of course, as any other valuation metric, ROA should be compared to the industry benchmark or a group of similar companies that operate in the same industry.
Otherwise, a plain percentage says nothing, and analysts or investment managers are not shooting for a specific percentage.
For instance, there may companies with a ROA of 1% that are significantly better stocks than companies with a 20% ROA. There are also cases of companies like Enron, for example, that were deliberately showing high ROA ratios on their income statements as a means to attract more investors. So, at the end of the day, it all boils down to the industry.
Real-Life Examples (updated for 2022)
- ROA = ROTA
- Apple ($AAPL) = 28.9%
- Microsoft ($MSFT) = 21.4%
- Google ($GOOGL) = 21.3%
- Amazon ($AMZN) = 5.4%
- Tesla ($TSLA) = 13.9%