In late February, I published and commented on a chart depicting the path of US and Canadian government bond yields since the 2016 US Presidential election. An updated chart, showing yields up to and including April 25th, is shown below.
As you will note, government bond yields crept up to their post-election highs in the days leading up to the March 14th-15th Federal Open Market Committee (FOMC) meeting in the US. During the lead-up to this meeting, Federal Reserve officials sent strong and rather clear signals that, given the Fed’s economic assessment, an increase in the Fed Funds rate target on March 15th was a near-certainty (and additional increases in the near future were to be expected). Bond markets responded to these signals. (And indeed, at its meeting, the FOMC ultimately hiked the Fed Funds target by 25 basis points (0.25%)).
Since then, government bond yields have generally been declining, due to mixed US economic data (e.g., slowing pace of job growth) and likely due to perceived political uncertainty and the impact on the economy. For example, the failure to repeal and replace ObamaCare in a Republican-dominated Congress may suggest that the implementation of the US President’s agenda may not be a slam dunk (see my first post/blog on interest rates). And, while tax cuts may be less contentious than health care, the timing and extent of tax relief that the President and Congress can agree to remain to be seen.
Originally posted on LinkedIn on February 23, 2017
Equity markets have been on a tear in the US and Canada since the US presidential election. Government bond yields also spiked initially, given the market's expectations concerning fiscal stimulus (lower taxes, higher infrastructure spending) and deregulation.
However, while equity markets have continued to exhibit upward trajectory in 2017, government bond yields appear to have taken a pause. In fact, 2-year, 5-year, and 10-year yields on both sides of the border have yet to recover from their post-election highs in mid- to late December 2016 (though they certainly tried to around inauguration).
Arguably, uncertainy around the amount and timing of fiscal stimulus (which requires some cooperation from Congress), as well as uncertainty around trade policy, immigration, and other issues, has led bond market participants to temper their expectations.
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Originally Published on LinkedIn on August 16, 2016
© Neil Lindsay, 2016
Based on the questions I’ve received over the years, and conflicting information available on the Internet, there seems to be a lot of confusion about how to calculate a company’s Return on Assets (ROA).
Fortunately, there is at least some consensus on what the denominator of the ROA ratio should be – the company's Average Total Assets for the period. (Quibbles remain on whether certain assets should be excluded from Average Total Assets, but any adjustments would be driven by the objectives of your analysis. However, to quote from Hammy Hamster, “that’s another story”.)
Unfortunately, there appears to be two distinct views on what the numerator (i.e., the income flow or return to be measured) should be:
Ultimately, the appropriate numerator is the one that is aligned with the denominator and the objective of the ROA ratio.
Objective of the ROA Ratio
Arguably, the ROA ratio is used to evaluate how productively and efficiently the assets of a company are being used.
Net Income vs. EBIT
At first glance, Net Income seems to make sense as an appropriate numerator. After all, it captures revenues and operating expenses, and is used in the wildly popular Return on Equity (ROE) ratio.
However, Net Income also includes interest expenses, which are driven by the company’s capital structure choices (namely, how much debt it uses). What, then, are the implications of using Net Income as the numerator in ROA?
Well, let’s say Company A and Company B have the same amount and composition of assets, sales, and operating costs. But, Company A has no debt, while Company B is financed 50% with debt. In this situation:
But do these differing ROAs make sense? If the objective is to measure how productively and efficiently the assets of a company are being used, then the answer is a resounding “NO”. With this objective in mind, we should not care how the assets in question are financed. We should only care about how the assets are being used by the firm. (Bonus points if Fisher’s Separation Theorem just popped into your head.)
Instead, we need a numerator that is untainted by the firm’s financing choices. Put another way, we need a measure of income for all of the assets quantified in the denominator, not just the portion of assets funded by equity investors. And, because it calculates earnings before interest expenses are deducted, EBIT fits the bill quite nicely. (Note: If an after-tax ROA is desired, EBIT can be adjusted to an after-tax number.) Whereas Net Income is a measure of earnings attributable to just the equity investment in the firm (or the portion of assets funded with equity), EBIT is a measure of earnings attributable to all of the assets of the firm.
Therefore, in this author’s opinion, ROA = EBIT/Average Total Assets. Under this formulation, the firm-wide numerator corresponds with the firm-wide denominator. And, most importantly, the ratio measures how productively and efficiently the assets of a company are being used, regardless of how the firm is financed.
As an aside, I suspect that the debate over the ROA numerator stems from one of the major tensions between accounting and finance. Accounting classifies interest as an operating expense, whereas finance treats interest as a financing expense. These different approaches lead to a number of analytical issues - but that’s another story…
DISCLAIMER: Some authorities, programs and courses insist that ROA = Net Income/Average Assets, or perhaps some other formula. Therefore, depending on the circumstance and your objectives, you may wish to use these alternative definitions of ROA (e.g., to pass or maximize your grade in a program or course that uses an alternative definition).
Neil Lindsay, BBA, MBA is a finance lecturer, tutor, and consultant, who has been teaching finance to MBA, Executive MBA, and professional students for nearly fifteen years. He is also an award-winning finance and public policy professional, with private sector and pubic sector experience in corporate finance, capital markets, and risk management. Neil may be reached at firstname.lastname@example.org.
© Neil Lindsay, 2016
Neil Lindsay, BBA, MBA is a finance lecturer, tutor, and consultant, who has been teaching finance to MBA, Executive MBA, and professional students for fifteen years. He is also an award-winning finance and public policy professional, with private sector and pubic sector experience in corporate finance, capital markets, and risk management. Neil may be reached at email@example.com.