Business Studies
You are writing a book on how to evaluate performance evaluation for a company.
Respond to the following in a minimum of 175 words:
• Think about some of the influences and measures of company performance that you read about this week.
• Explain the use of return on assets (ROA) and the price-to-earnings (PE) ratio in evaluating the performance of a company.
• Write about how to calculate ROA and PE ratio and how market conditions can affect these metrics.
• Share the ROA and PE ratio for a company you are familiar with. What do these metrics tell you about the financial health of the company?
ANSWER
Performance Evaluation
Performance evaluation is essential for every company. Determining how well a company is doing can be done in several ways, key among them; a comparison of initiative results with the targets and application of financial indicators to tell how well a company is performing and comparing it with other companies in the same industry.
Return on assets (ROA) reveals the amount of profits a company has made from its assets. It shows investors how good the company is at the conversion of investments to income. A high ROA show a positive performance of the company. Price to earnings ratios (PE), on the other hand, show what the price market pays for stock on a particular day based on the present and future earnings. Additionally, the PE ratio depicts the amount of money an investor would be willing to pay for the stock based on future growth expectations. A high PE means that the price of the stock is high in comparison to its earnings.
To calculate ROA, the average total assets are used. Using the figure of net income or net profit in a company’s balance sheet, we can calculate the ROA by dividing the average total assets’ net income. For example, let’s use Exxon Mobil Corporation with total assets of $349 billion and $330 billion in 2017 and 2018. On average, the total assets are $339.5 billion. From the company’s income statements, the net income for the year 2017 is $19.7 billion. To calculate the ROA:
Exxon’s ROA = $19.7 Billion / $339.5 Billion
=5.8%
To calculate the PE ratio, we divide the price per share by the earnings per share. An example, let’s compare Bank of America and JPMorgan Chase. Bank of America in 2017 closed the year with the following.
Stock Price = $29.52
Diluted EPS = $1.561
PE = $29.52 / $1.56
=18.92
JPMorgan Chase closed the year 2017 with the following:
Stock Price = $106.94
Diluted EPS = $6.313
PE = $106.94 / $6.313
=16.94
From the calculations, we can deduce that investors in Bank of America with a PE of 19 expected more earnings in future growth compared to JP Morgan’s PE of 17.
References
Asiri, B. K. (2015). How investors perceive financial ratios at different growth opportunities and financial leverages. Journal of Business Studies Quarterly, 6(3), 1.
