One of the key factors in the success of any company is the effectiveness of management.  Decisions made on the management level can dramatically enhance or hurt the performance of a company.  There are two measures that we will touch on today that can give us insight into how well management is performing 1) Return on Assets and 2) Return on Equity.

Return on Assets is an indication of how effectively a company can achieve a return relative to the amount of total capital invested.  The formula for ROA is Net Income divided by Total Assets.  The higher the number generated by the formula the better.  If management through the myriad of decisions and resources available to them can achieve a high return, then that management team is performing well.  It is best to compare performance against the company itself quarter over quarter or year over year.  It is also prudent to compare performance to other companies in the same or similar industries.

Return on Equity is similar to ROA in that it is a measure of management performance and their ability to generate a return.  ROE measures how well the company can yield a return in relation to the shareholders equity or stock holdings.  The formula for ROE is Net Income divided by Shareholder’s Equity.  The higher the number generated by the formula the better.   As with ROA the measure is most meaningful by comparing the company over time against its’ own performance as well as a comparison against other companies in similar industries.

When considering whether or not to invest in a company, management effectiveness should be a crucial part of your due diligence and these measures will help you in that decision.  Robin

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