What is 'Asset Turnover Ratio'
Asset turnover ratio is the ratio of the value of a company’s sales or revenues generated relative to the value of its assets. The Asset Turnover ratio can often be used as an indicator of the efficiency with which a company is deploying its assets in generating revenue.
Asset Turnover = Sales or Revenues / Total Assets
Generally speaking, the higher the asset turnover ratio, the better the company is performing, since higher ratios imply that the company is generating more revenue per dollar of assets. Yet, this ratio can vary widely from one industry to the next. As such, considering the asset turnover ratios of an energy company and a telecommunications company will not make for an accurate comparison. Comparisons are only meaningful when they are made for different companies within the same sector.
BREAKING DOWN 'Asset Turnover Ratio'
Asset turnover is typically calculated over an annual basis using either the fiscal or calendar year. The total assets number used in the denominator can be calculated by taking the average of assets held by a company at the beginning of the year and at the year’s end.
For example, suppose company X has an asset base of $400 million at the beginning of a given year and $500 million at the end of the same year, and suppose that company X generated $900 million in revenues over the course of that year. The asset turnover ratio for company X is therefore:
$900 million / [($500 million + $400 million) / 2] =
$900 million / [$900 million / 2] =
$900 million / $450 million = 2.00
The asset turnover ratio tends to be higher for companies in certain sectors than in others. Retail, for example, is the sector that most often yields the highest asset turnover ratios, scoring a 2.05 in 2014. Both it and consumer staples have relatively small asset bases but have high sales volume.
Conversely, firms in sectors like utilities and telecommunications, which have large asset bases, will have lower asset turnover. The financial sector, for example, often trails in its asset turnover ratio, scoring a 0.08 in 2014.
Using the Asset Turnover Ratio
Consider the asset turnover ratio for Wal-Mart Stores Inc. (WMT). When the fiscal year ended on January 31, 2014, Wal-Mart had total revenues of $476 billion. Wal-Mart’s total assets were $203 billion at the beginning of that fiscal year and $205 billion at fiscal year-end, for an average of $204 billion. Wal-Mart’s asset turnover ratio was therefore 2.36 ($476 billion/ $204 billion).
In contrast, AT&T Inc. (T) had total revenues of $132 billion when the fiscal year ended on December 31, 2014. Total assets at the beginning and end of the 2014 fiscal year were $278 billion and $293 billion respectively, for an average asset base of $287 billion. AT&T’s asset turnover ratio in 2014 was therefore 0.46 ($132 billion / $287 billion).
Clearly, it would not make much sense to compare the asset turnover ratios for Wal-Mart and AT&T, since they operate in very different industries. But comparing the asset turnover ratios for AT&T and Verizon Communications Inc. (VZ), for instance, may provide a clearer picture of asset use efficiency for these telecom companies. In the same fiscal year as in the AT&T example above, Verizon had total revenues of $127 billion. Total assets at the beginning and end of the year were $274 billion and $232 billion, respectively, for an average asset base of $253 billion. As such, in 2014 Verizon’s asset turnover ratio was 0.50 ($127 billion / $253 billion), about 9% higher than AT&T’s in the same year.
Yet, this kind of comparison does not necessarily paint the clearest possible picture. It is possible that a company’s asset turnover ratio in any single year differs substantially from previous or subsequent years. For example, while AT&T’s asset turnover ratio was 0.30 in 2006, it rose nearly a full fifty percent to reach 0.44 in 2007, the following year. For any specific company, then, one would do well to review the trend in the asset turnover ratio over a period of time to check whether asset usage is improving or deteriorating.
Many other factors can affect a company’s asset turnover ratio in a given year, such as whether or not an industry is cyclical. (For more, see: Cyclical Versus Non-Cyclical Stocks.)
History
The Asset Turnover ratio is a key component of DuPont analysis, a system that the DuPont Corporation began using during the 1920s. DuPont analysis breaks down Return on Equity (ROE) into three parts, one of which is asset turnover, the other two being profit margin and financial leverage. In splitting ROE into distinct components, this form of analysis allows one to analyze the nuances of a high or low ROE, to attempt to determine what causes may be contributing to a company’s ROE performance and to compare the components of ROE with those of other companies.
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