Here is a riddle for you: if one company has 10 assets and another has 100 assets, which one will you choose to invest in?
Before you answer, you were about to give the most biased response of all time. The best way to answer this question is by using a financial ratio called “ROA” Return on Assets. This ratio shows how profitable a company is against its total assets. ROA can be used by corporate management, analysts, and investors to determine how effectively a company uses its assets to generate a profit.
However, when using this financial ratio, I find that there are a lot of outliers. One of the most significant limitations of ROA is that it is not comparable across industries. This is because companies in one industry have different asset bases than those in another. As a result, the asset bases of companies in the oil and gas industry differ from those in the retail industry.
So the best financial ratio that you can use is “The ROIC” Return on invested capital.
The return on invested capital (ROIC) calculation is used to evaluate a company’s efficiency in allocating capital to profitable investments.
Return on Invested Capital = NOPAT / Invested Capital
This financial metric considers both equity and debt returns. ROA indicates how effectively a company uses its existing assets to generate profits. ROIC measures a company’s ability to reinvest in itself.
Most billionaires relied on this financial metric besides other valuation methods.
