Ratios for Business Decision-Making: Part 1 – ROE & ROA
I will be revisiting, mostly for my own refreshment, different ratios that are helpful when trying to understand the performance of a business (or business unit) from material from my MBA classes over these last two years. I find that knowledge is solidified in my mind through writing.
To practice the exercise, we will be using NVIDIA Corp. 2024 Financial Statements as find on EDGAR or NVIDIA website.
Financial ratios are simple comparisons between different numbers in a company's financial statements. They help you understand how well the company is making money (profitability), managing its cash (liquidity), and handling its debts (solvency). Even if companies use different terms or choose different starting points for their numbers, the ratios are still useful as long as they are calculated the same way each time.
Profitability ratios show how effectively a company is turning its investments into profits (value creation) over a certain period. They help you see how well the company is making money from what it has invested.
Profitability Ratios
ROE (Return on Equity)
Return on Equity measures how much profit a company makes with the money shareholders have invested. It is calculated by dividing net income by shareholders' equity. This percentage shows the profit the company generates for its owners over a specific period.
Formula:
$$\text{ROE} = \frac{\text{Net Income}}{\text{Shareholders' Equity}}$$
Lets take the case of NVIDIA.
1. ROE for January 28, 2024
- Net Income: $29,760 million
- Shareholders' Equity: $42,978 million
Formula:
$$\text{ROE} = \frac{\$29,760}{\$42,978}$$
Calculation:
$$\text{ROE} = \frac{29,760}{42,978} \approx 0.692 \text{ or } 69.2\%$$
2. ROE for January 29, 2023
- Net Income: $4,368 million
- Shareholders' Equity: $22,101 million
Formula:
$$\text{ROE} = \frac{\$4,368}{\$22,101}$$
Calculation:
$$\text{ROE} = \frac{4,368}{22,101} \approx 0.1977 \text{ or } 19.77\%$$
Summary of ROE Calculations
| Date | Net Income (Millions) | Shareholders' Equity (Millions) | ROE (%) |
|---|---|---|---|
| Jan 28, 2024 | $29,760 | $42,978 | 69.2% |
| Jan 29, 2023 | $4,368 | $22,101 | 19.77% |
Interpretation
- January 28, 2024:
An ROE of 69.2% indicates that for every dollar of shareholders' equity, the company generated approximately 69.2 cents in profit. This is a substantial increase from the previous year, suggesting a significant improvement in how efficiently the company is using its equity to generate profits compared to 2023. - January 29, 20243:
An ROE of 19.77% means that for every dollar of shareholders' equity, the company generated about 19.77 cents in profit.
ROA (Return on Assets)
Return on Assets indicates how efficiently a company uses its assets to produce profit. It is calculated by dividing net income by total assets. ROA shows how much profit is made for each unit of currency invested in the company's assets. One benefit of ROA is that it can be used to evaluate individual parts of a business, not just the whole company.
Formula:
$$\text{ROA} = \frac{\text{Net Income}}{\text{Total Assets}}$$
Lets take the case of NVIDIA.
1. ROA for January 28, 2024
- Net Income: $29,760 million
- Total Assets: $65,728 million
Formula:
$$\text{ROA} = \frac{\$29,760}{\$65,728}$$
Calculation:
$$\text{ROA} = \frac{29,760}{65,728} \approx 0.452 \text{ or } 45.2\%$$
2. ROA for January 29, 2023
- Net Income: $4,368 million
- Total Assets: $41,182 million
Formula:
$$\text{ROA} = \frac{\$4,368}{\$41,182}$$
Calculation:
$$\text{ROA} = \frac{4,368}{41,182} \approx 0.1060 \text{ or } 10.6\%$$
Summary of ROA Calculations
| Date | Net Income (Millions) | Total Assets (Millions) | ROA (%) |
|---|---|---|---|
| Jan 29, 2023 | $4,368 | $41,182 | 10.6% |
| Jan 28, 2024 | $29,760 | $65,728 | 45.2% |
Interpretation
- January 29, 2023:
For every dollar of assets, NVIDIA generated about 10.6 cents in profit. This provides a baseline for comparing the following year’s performance. - January 28, 2024:
For every dollar of assets, NVIDIA generated roughly 45.2 cents in profit. This represents a huge increase from the previous year’s 10.6%, indicating that net income has grown much faster than total assets.
What Do We Make of This Data So Far?
Both ROE and ROA show a dramatic year-over-year improvement. Here’s the high-level takeaway:
- ROE (19.77% → 69.2%): The jump suggests that NVIDIA used shareholders’ equity far more effectively in 2024 than in 2023. For every dollar of equity, they generated significantly more profit.
- ROA (10.6% → 45.2%): The asset base expanded from $41.2 billion to $65.7 billion, but net income grew at a pace that far outstripped that increase. The result is a substantial rise in ROA, indicating high efficiency in deploying those assets.
Questions to Consider:
What fueled the surge in net income? Could it be a one-time event, a new product success, pricing strategy, or a long-term trend driven by AI or data-center demand?
Is asset growth sustainable? Rapid asset growth often points to R&D, acquisitions, or expansions. Are these investments likely to keep driving returns?
How does this compare to peers? Are these ratios typical for the semiconductor or tech industry, or is NVIDIA pulling ahead?
What about capital structure? With equity up significantly, how much of that comes from retained earnings versus new equity issuance? And how has debt changed in the same timeframe?
Next Steps: More Ratios Ahead
In the upcoming posts, we’ll dive into other useful ratios that add context to ROE and ROA:
- Profit Margin (how much profit is left after covering costs)
- Asset Turnover (how efficiently assets generate revenue)
- Equity Multiplier (how leveraged the company is)
- Liquidity Ratios (e.g., Current Ratio)
- Solvency Ratios (e.g., Debt-to-Equity, Interest Coverage)
These additional metrics will help you build a fuller understanding of a company’s operational efficiency, financial stability, and overall performance. Until next time, stay curious.
J