Return on Asset = Net Income / Total Asset
Total asset consist of debt and equity. This percentage gives the percentage of net income generated for the money invested which includes both debt and equity capital. As long as ROA is high, company shareholders will be greatly rewarded.
What is the Company’s ROA for the last 10 years? Is it growing constantly or at least maintaining an average ROA for the last 10 years?
You need to compare the ROA with competitors in the same industry. As an investor, you need to identify which industries are offering a higher ROA.
Does the Company have consistent ROIC numbers?
Here is the formula to calculate the Return on Invested Capital
ROIC = (Net Income – Dividends) / Total Capital
Total capital includes long-term debt and common and preferred shares. The higher the ROIC, the better it is for the investors. If the ROIC is very high, it means management is doing a great job of allocating capital profitably.
Does the Company need to spend large amount of money as a capital expenditure to stay competitive?
You should examine capital expenditures over time. If a company is spending large amounts of revenue as a capital expenditure, then it is not a great business. If a company is not spending large amounts of money, it is unlikely that it can be competitive in its industry. This applies to manufacturing and auto industries.
After capital expenditures, there will be less money available for other good things to increase shareholder value, such as expanding the business, buying back shares, acquiring other businesses and paying dividends. If a company is spending large portions of its revenue for capital expenditures, it will be difficult to spend money to increase shareholder value over time.
What is the Company’s Investing Strategy? Is the Company Investing in its Area of Expertise?
When a company earns income for its owners every year and increases that income, the cash is going to pile up. You need to find out what a company is doing with that cash. When a company tries to invest those earnings back into growth, you need to identify where it is sinking its investment dollars. If its strategy is growing through acquisition, you need to find out how the company management plans on acquiring companies. Is the business that management hopes to acquire related to existing business, or is it a totally different business?
You need to also examine whether or not a company invests in its area of expertise. This is important. If a company tries to buy totally different kinds of business and then tries to integrate the new companies, this is a bad move.
What percentage of revenue is spent on Research and Development?
R&D is an important task for most business because it allows the business to invent new products, upgrade existing products, increase efficiency, and decrease production costs.
R&D is very important task for technology companies. If technology companies do not invent new products all the time, competitors can kill them and take their market share. Investing a certain percentage of revenue in R&D is important for a company’s growth. Spending alone does not increase the revenue of the company. You need to identify how effective the current management is at generating returns on their investments. They have to generate a good return on their investment.
Compare similar companies in the same industry and their previous new product inventions and the revenue generated from those products. If the company is not introducing new products all the time, it is in danger of losing revenue. When you are looking at a company, pay special attention to find out how effectively its previous R&D activities delivered revenue. If you find a company that does have R&D expenses and has also grown more than 15 percent for the last five years then you have found a good company and do research from there.