Question

You are writing a book on how to evaluate performance evaluation for a company.

Respond to the following in a minimum of 175 words:

• Think about some of the influences and measures of company performance that you read about this week.
• Explain the use of return on assets (ROA) and the price-to-earnings (PE) ratio in evaluating the performance of a company.
• Write about how to calculate ROA and PE ratio and how market conditions can affect these metrics.
• Share the ROA and PE ratio for a company you are familiar with. What do these metrics tell you about the financial health of the company?

Answer 1

ROA and PE are important financial metrics that can be used to evaluate the financial health of a company. ROA or return on assets is a profitability ratio and reflects the final result of the operations of a company or a business. ROA is a rate of return ratio and the formula is: ROA = net income/average total assets. This rate of return measure uses the total assets as the base and hence indicates how efficiently the assets of a company are used and how efficiently its capital is employed.

PE ratio (or price-to-earnings ratio) is a valuation ratio and like other valuation ratios it indicates how the equity of a company is assessed in the capital market. It should be noted that market value of equity reflects the combined influence of risk and return and hence valuation measures like PE ratios are important. PE ratio = market price per share/earnings per share. PE ratio reflects growth prospects, risk characteristics, shareholder orientation, corporate image and degree of liquidity for a company and its stock.

A company that I am familiar with is GE (General Electric). The company’s ROA is 1.39% (trailing twelve months) and its PE is 11.72 (trailing twelve months). These metrics helps me to gauge the financial health of GE to a certain extent. The company’s ROA is 1.39% and this indicates that the company is earning $1.39 as net income for every $100 assets used by it. This is a fairly good number given the industries that GE is present in. The company’s PE ratio is 11.72 and this indicates that the stockholders and market view that growth prospects of GE is fairly good and it is for this reason that they are giving the company’s value a premium relative to its earnings.

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