This video shows how to break a company’s Return on Assets (ROA) down into two components: Profit Margin and Asset Turnover.
ROA = Net Income / Average Total Assets
is equivalent to saying that:
ROA = Profit Margin * Asset Turnover
because Profit Margin is Net Income divided by Net Sales, whereas Asset Turnover is Net Sales divided by Average Total Assets
Decomposing ROA into Profit Margin and Asset Turnover is important because it tells you about a company’s strategy and why its ROA is high or low relative to the company’s competitors. Some companies rely on a high Profit Margin (e.g., a luxury car dealership) whereas other companies rely on high Asset Turnover (e.g., a grocery store, which doesn’t make a lot of profit with each sale, but should generate a large amount of sales given its assets).