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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Return on assets offers clues on efficiency

Universal Press Syndicate

A steel company is “capital intensive,” requiring costly equipment to generate its earnings. Software companies, on the other hand, typically have a much lighter business model. Once the software has been developed, it’s simply a matter of copying it onto disks, packaging it and marketing it. Such businesses tend to be more profitable.

Investors can measure a company’s asset-heaviness by calculating its return on assets (ROA). There are a few steps involved in this, but they’re not too tough. (Got your pencil ready?) You’ll find all the numbers you need on a company’s recent balance sheet and income statement. We’ll use Barnes & Noble’s fiscal 2004 results as an example.

The simplest way to calculate return on assets is to divide net income for a period by the period’s average total assets. To get net income, look near the bottom of the income statement. Barnes & Noble’s is $143 million. The year-end balance sheet is where you’ll find total assets, but they’ll reflect assets on the last day of the period only. So grab the total assets number for the end of the previous year and average the two, to get a sense of asset level throughout the year. When we add 2004’s $3.3 billion and 2003’s $3.8 billion and divide by two, our average is $3.55 billion. Divide $143 million by $3,550 million (which is another way of expressing $3.55 billion), and you’ll get 0.04, or 4 percent.

That means that Barnes & Noble generates 4 cents in profit for each dollar of assets. Compare that with Amazon.com, which sports a recent ROA north of 25 percent. That means the company wrings more than 25 cents of profit from each dollar of assets. This shouldn’t be surprising, because Barnes & Noble sports more than $2 billion in property, plants and equipment, compared to just $245 million for Amazon.com. It simply has a lot of physical outlets, whereas Amazon maintains some warehouses and electronic storefronts.

Compare the ROAs of competitors in an industry, and you’ll get an idea of which firms are most effective.

Ask the Fool

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Note that commissions at many brokerages have fallen to as low as $5 or $10 per trade. This is a far cry from the typical discount commission of $30 to $50 a few years ago and the hundreds of dollars that some full-service brokerages will still charge you today.

Q: How long do I have to keep financial records for tax purposes? — H.S., Jacksonville, N.C.

A: It depends. Keep copies of all your tax returns forever. You never know when they’ll come in handy. Keep canceled checks, deposit statements and receipts for at least three years, ideally seven. (If a check is for something related to next year’s tax return, you should hang onto it for an extra year.) Hang on to your stock trade confirmation receipts and statements for as long as you own the stock and for at least three years (ideally seven) after you close out your position in the stock (usually by selling). Keep proof of improvements to property for at least three years after the sale of the property.

My dumbest investment

I bought shares of drug maker Alteon in 2001 for around $3 per share after a sharp drop (from $7) on bad news. As an experienced medical researcher, I had great hopes for its drug that’s now known as Alagebrium. I turned down a chance to sell at $4, and then lost most of my investment when the stock dropped to $1 per share. It has recently been trading around $0.25 per share.

R.L.P., Abingdon, Md.

The Fool Responds: Good lessons. Be wary of any company if it relies significantly on just one product — or one outlet. (Firms that sell half their wares to Wal-Mart, for example, are vulnerable to Wal-Mart’s whims.) And volatile penny stocks (which trade for less than $5 per share) are worth avoiding.