Accounting Ratios

Return on Production Assets (%)

We penalise companies where returns on production assets are either too high (suggesting a company is a fraud) or too low (suggesting poor competitiveness) relative to industry peers. Return on production assets is calculated as operating profit over net fixed assets, inventory and prepaid lease payments. We prefer this metric as opposed to return on capital employed as the latter metric can be distorted by frauds. For example, companies generating fake cash will see a significant rise in assets which lowers returns. It is likely harder to fake real production assets.

Globally, the median average return on production assets was 15% between 2010 and 2015; however, there is considerable variance by industry as Figure 123 shows. The highest returns are generated by businesses with the lowest fixed assets and the highest intellectual property component, such as Software and I.T.. The lowest returns are generated by asset heavy industries such as Property and Electricity Utilities.

Under our accounting screen a red flag is triggered when returns on production assets is below the 20th percentile or above the 80th relative to industry peers (i.e. it is either very high or very low). Red flags are also triggered when changes in returns are unusually large over 1 and 3 years. Again, this is when the increase is below the 20th percentile relative to industry peers between 2010 and 2015, or the drop exceeds the 80th percentile.

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