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Assignment 2 Portfolio management

Student name: Fatema Khela ID number: 200920046

What is the different between ROA (return on assets) and ROE (return on equity) as general policy, which measure do you think should be preferred for evaluating investment ROA or ROE? Explain in two hundred words.

ROA: is the profit generated from each dollar of assets .Generally,


the higher the ROA, the more efficient the management is at generating profit. Earnings before interest and taxes divided by total assets.

ROE: is the return on each dollar invested into the company. This is
a very good indicator of attractiveness of the investment, as higher ROE means we are getting a good return on our investment. The ratio of net profits to common equity.

Difference between ROA and ROE


ROA shows our how much money we are able to get based on how much stuff we have to get it with. ROE shows our how much money we able to get based on how much money assistance we got from others.
High Assistance+ low profits = Low ROE Low Assistance+ high profits= High ROE

If we want to give our money to companies that are able to make big profits with little assistance then search for companies with High ROE.
High Assets+ Low profits= Low ROA Low Assets + High Profits= High ROA

ROE is nothing but a measure of how much profit a company generates with the money shareholders have invested. In other words how effectively the company uses the money invested by investors.
ROE= (Annual Net Income/ Average Shareholders Equity) The net income can be found out from the income statement, and the average shareholders equity form balance sheet.

ROA is nothing but a measure of how much profit a company earns for very dollar of its assets. Again this reveals how effective the company management is. Assets include like cash in the bank, accounts receivable, property, equipment, inventory and furniture.
ROA= (Annual Net Income/ Total Assets)

The important factor that separates ROE and ROA is debt. Accounting tells us, Assets= Liabilities+ Shareholders Equity.

Which measure do you think should be preferred for evaluating investment ROA or ROE?
Profitability measures focus on the firms earnings. To facilitate comparisons across firms, total earnings are expressed on a perdollar-invested basis. So return on equity (ROE), which measures profitability for contributors of equity capital, is defined as (after tax) profits divided by the book value of equity. Similarly, return on assets (ROA), which measures profitability for all contributors of capital, is defined as earnings before interest and taxes divided by total assets. Not surprisingly, ROA and ROE are linked, but as we will see shortly, the relationship between them is affected by the firms financial policies.

Conclusion

Before trading in a stock, always we must keep an eye on the ROE and ROA. They are different, but together they provide a clear picture of management effectiveness. If ROA is sound and debt levels are reasonable, a strong ROE is a solid signal that the company is doing a good job of generating returns from shareholders investments. ROE is certainly a hint that management is giving shareholders more for their investors a false impression about the companys fortunes.