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December 1, 2009
Components of RNOA: Profit Margin and Asset
Turnover
Previously, I touched on the importance of Return on Net Operating Assets (RNOA), specifically
with respect to my view that it's foolish to examine a firm's ROE without an idea as to the
relative contributions of operating and nonoperating returns. I'd like to examine RNOA a bit
further, and place some emphasis on it's dual components of margin and turnover. Just to
refresh, the original formula for Operating Return is:
RNOA = Net Operating Profit After Taxes ÷ Average Net Operating Assets
In order to illustrate the margin and turnover components, I'll create a new, equivalent
equation:
RNOA = (Net Operating Profit Margin ÷ Sales) X (Sales ÷ Net Operating Asset Turnover)
Therefore:
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December 1, 2009
RNOA = Net Operating Profit Margin (NOPM) X Net Operating Asset Turnover (NOAT)
Truthfully, I don't blame you if this still doesn't make a whole lot of sense. So, let's look at this
using some real numbers from the largest employer in the world/retail titan..WalMart (WMT).
Above I've included every part of an equation necessary to understand RNOA's components of
NOPM and NOAT. Keep in mind that WalMart's RNOA was originally calculated using
NOPAT/RNOA, or $15,637/$109,987 to yield 14.22%. To calculate Net Operating Profit Margin
(NOPM) I took NOPAT of $15,637 and divided it by 2009 revenue of $401,244. The resulting
3.9% seems rather feeble for such a monster like WalMart; it means that for every dollar of
sales revenue, WalMart is only earning 3.9 cents of after tax operating profit. Remember
though that the margin is somewhat useless in the absence of turnover figures. To calculate Net
Operating Asset Turnover (NOAT), I took 2009 revenue of $401,244 (millions by the way, crazy
right) and divided it by Average Net Operating Assets of $109,987. The resulting NOAT is 3.65.
Now multiply 3.9 (NOPM) by 3.65 (NOAT); the result should look familiar ‐ 14.2%. Walmart's
figures highlight an important concerning the relationship between margins and asset turnover.
A high margin firm won't necessarily earn healthy returns for shareholders; it all depends on
the turnover they are able to achieve given that level of margin.
I included WalMart's 20.63% ROE just to illustrate that the company is earning a very healthy
operating return component of 69% (14.22RNOA / 20.63ROE). Interestingly, the company
doesn't highlight this ratio in its financial presentations. Rather, they use a modified return on
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December 1, 2009
investment (ROI) formula that takes operating income as its starting point, and adds back in
some non‐cash adjustments for depreciation and amortization to arrive at the numerator. In
the denominator, WalMart creates an average operating assets figure, similar to NOA except
that operating liabilities are not netted out of the equation. Although investors should keep an
eye on these metrics that are recommended by management, don't forget that they are non‐
GAAP and are probably suggested for a reason.
*no positions
Copyright 2009 ‐ The Value at Risk
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