Return on Assets (ROA) is a measure of a company’s profitability. ROA is calculated as the net income of a company divided by the company’s assets.

As with everything that is occasionally defined arbitrarily, you should know how a reported ROA is actually being calculated. Most analysts would exclude dividends paid to preferred shareholders from net income, and the company’s assets are usually calculated as an average over a certain given period. ROA is closely related to Return on Equity (ROE) – essentially, it is ROE divided by the company’s leverage (total assets divided by shareholders equity).

ROA is one way to gauge the performance of a company’s management – with higher ROA generally equating to better management – especially when comparing companies in the same industry. It is also useful to look at the ratio of ROE to ROA. The larger the ratio of the two ratios, the more leverage (debt) a company has taken.

Generally, a high ROA and a low ratio of ROE to ROA are good. However, investors need to look at numbers like ROE and ROA and then look at the underlying numbers to see how the ratios were derived. Habits such as reading a company’s annual report and visiting Web sites like Morningstar at www.morningstar.com are invaluable when assessing what a company’s valuation ratios mean. For example, a billion dollar refinery that has been depreciated to zero will show up on a company’s books as an asset, but it is still generating profits, which will skew the value of the company’s ROA higher.