Find out why RNOA (Return on Net Operating Assets) is a better way to analyze than ROE (Return on Equity)
Everyone uses ratios to analyze the performance of a company. This includes CEOs or CEOs, CFOs or CFOs, CFOs, CFOs, accountants, and even market analysts, security experts, and outside investors. These ratios are calculated and analyzed to understand how effective and healthy the business is, and also to know if the management is doing a good job or not. Ratios are effective ways to correctly organize and analyze a large amount of information.
All kinds of ratios are used, but perhaps the most popular among them is ROE or Return on Equity. However, there is another one that is gaining popularity, and this is the RNOA or Return on Net Operating Assets. The fact is that more and more investors, analysts and companies use RNOA to organize data and perform analysis. RNOA is believed to give the most appropriate image of the business and its relationship with competitors.
Now let’s take a closer look at both ROE and RNOA to understand why RNOA might be a better model.
ROE explained
What is ROE? As mentioned above, ROE is the return on equity. Explained in simpler terms, it is the ratio of earnings after taxes calculated on invested assets. For the shareholder, ROE is an indication of how effective the business has been for the capital or shares held. This is how ROE is calculated.
ROE = Net Income/Average Common Equity
ROE has been further broken down according to DuPont’s 1919 principle, and this is what it looks like.
ROE = Net Income/Common Equity = Net Income/Net Sales x Net Sales/Common Equity
However, ROE may not be accurate because it is unable to separate financial and operating changes. For example, let’s say ROA or return on assets declined for the business. When this happens, the analyst may conclude that the business is not doing very well, while the ROE actually increased due to the use of leverage.
RNOA explained
RNOA or Return on Net Operating Assets is probably the best way to understand business performance. That’s because RNOA can separate operational and financial decisions.
This is how the RNOA is calculated.
RNOA = Operating Income After Taxes/NOA or Net Operating Assets
This ratio analysis is able to isolate NOA, and because of this, the conclusions reached are always accurate.