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In: Finance

Both ROE and ROA measure profitability. Which one is more useful for comparing two companies? Why?

Both ROE and ROA measure profitability. Which one is more useful for comparing two companies? Why?

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Expert Solution

The formula for calculating return on equity is net income divided by shareholder's equity. ROE tells us how effectively the company is utilising its equity or base capital to generate profit.

ROA is return on average assets. This measure marks the earning advantage of its base assets. ROA is best used as a comparison tool for comparing banks which have large amount of assets. Thus for asset based companies, ROA is the accurate measure for profitability and comparison. This is also a limitation of this measure. ROE on the other hand has an advantage over this as it is not asset based. A company must have assets for this measure but ROE is not asset dependent. This flexibility allows it to be applied to any line of business which is why it is also popular compared to ROA.

If one is interested in knowing how the company manages its assets, ROA is the ideal tool for that. However for comparison purpose ROE beats ROA.

jeff jeffy answered 1 year ago
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