Question

Explain the use of return on assets (ROA) and the price-to-earnings (PE) ratio in evaluating the performance of a company. How do you calculate ROA and PE ratio and how can market conditions affect these metrics?

Answer 1

Return on assets ration depicts how much profits, a business organization is able to make form its assets. In other words, it gives an idea to the investor about how efficient an organization is in converting its investments into net income. Higher ROA shows that the business organization is making more profit on less investment.

Price to earnings ratios depicts what price market is paying today for a stock on the basis of its present and future earnings. It also shows how much an investor is willing to pay for the stock because of its future growth expectations. High PE means that stock prices are high in relation to its earnings.

Investors can use both the ratios in determining the efficiency of the company. ROA will tell investors about the return on his investment. If ROA is high, an investor is more likely to invest in the company. On the other hand, PE will tell investors about the prices of the company's stock. If PE is high, investors are more likely to purchase the company's shares.

Part2)

ROA is calculated by dividing a company’s net income by total assets. As a formula, it would be expressed as:

Return on Assets = NetIncome/Total Assets

To determine the P/E value, one simply must divide the current stock price by the earnings per share (EPS)

P/E = market value per share / earnings per share

​ part3)

Stock prices are not always determined as a result of rational investor behavior. Stock prices also rise and fall in response to fear and greed, whether in response to overall market conditions or prevailing investor wisdom about a particular company and its stock. When stock prices are steadily rising, investors can become greedy, buying shares at higher prices in expectation of even higher prices. When stocks are falling, investors can panic and sell their shares out of fear they will fall even further, bringing prices down. Fear and greed do not have the same impact on earnings, so P/E ratios will rise and fall with rising and falling stock prices.