Companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. Companies in the retail industry tend to have a very high turnover ratio.
Asset Turnover is linked to Return on Equity (ROE) through Du Pont Formula:
Return on Equity (ROE)
= Net Income / Total Shareholder Equity
= (Net Income / Sales) x (Sales / Total Assets) x (Total Assets /Total Shareholder Equity)
= Net Profit Margin x Asset Turnover x Leverage Ratio
= Return on assets x Leverage Ratio
It is also linked to Return on Asset through Du Pont Formula:
Return on Assets (ROA)
= Net Income / Total Assets
= (Net Income / Sales) x (Sales / Total Assets)
= Net Profit Margin x Asset Turnover
In the article Joining The Dark Side: Pirates, Spies and Short Sellers, James Montier reported that In their US sample covering the period 1968-2003, Cooper et al find that firms with low asset growth outperformed firms with high asset growth by an astounding 20% p.a. equally weighted. Even when controlling for market, size and style, low asset growth firms outperformed high asset growth firms by 13% p.a. Therefore a company with fast asset growth may underperform.
Therefore, it is a good sign if a company's asset turnover is consistent or even increases. If a company's asset grows faster than sales, its asset turnover will decline, which can be a warning sign.
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