Lesson 6 of 7
Reading an asset turnover ratio
Asset turnover is the efficiency half of return on assets. Its level is an industry fact and says little; its direction is a company fact and says a lot.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Asset turnover is revenue divided by total assets: how many units of revenue each unit of assets produced in a year.
- Net margin multiplied by asset turnover equals return on assets, so a low turnover is not a defect on its own; it can be offset by a wider margin.
- Goodwill does not amortise, so an acquisition's drag on turnover does not fade with time the way a normal asset's does.
The ratio's level is mostly an industry fact: a distributor turns assets over several times a year on a thin margin, a pipeline turns them over a fraction of a time on a wide one, and asked in isolation neither figure has an answer. The direction over time, at one company, is the part worth reading.
An acquirer's turnover against an organic grower's, five years
- Organic grower
- Acquirer, acquisition in Year 3
Show the numbers
| Organic grower | Acquirer, acquisition in Year 3 | |
|---|---|---|
| Year 1 | 1.20x | 1.20x |
| Year 2 | 1.22x | 1.19x |
| Year 3 | 1.21x | 0.94x |
| Year 4 | 1.23x | 0.95x |
| Year 5 | 1.22x | 0.94x |
Why a low level is not a defect
Net margin multiplied by asset turnover equals return on assets, and the two are substitutes: a business can reach the same return from either end. A turnover of 0.6 asked on its own has no answer. Asked next to the margin, the pair describes how the return is being earned, which is why this figure belongs beside the margin rather than on its own.
Average or closing assets, and the year of an acquisition
The numerator covers twelve months and the denominator is a balance on one day, so some averaging is the better match, though closing assets is what most published figures use. The choice barely matters in a flat year and matters a great deal in a year with a large acquisition.
What else sits in the denominator and earns nothing
Cash. A large balance sits in total assets and produces no revenue, so a cash-rich company reports a lower turnover with no operational difference, and a company that has just raised money reports a worse ratio the day the money arrives.
Asset age. Property carried at cost less depreciation shrinks every year it is held, so an old, heavily depreciated asset base reports a higher turnover than an identical one just rebuilt, and the newer plant is the one with worse optics.
Goodwill. Acquired intangibles with finite lives amortise and leave the denominator gradually. Goodwill does not: under ASC 350 it is tested for impairment rather than amortised, and it is written down only in the year a test fails. An acquisition's goodwill therefore stays in total assets at full amount indefinitely. An acquisitive company's asset turnover is permanently lower than that of a company that built the same capacity itself. That is unlike the acquisition effect above, which fades as revenue catches up.
Where the direction is scored
Joseph Piotroski's F-score sums nine yes-or-no tests in three groups: profitability, leverage and liquidity, and operating efficiency. One of the two efficiency tests scores a point when asset turnover rose on the year. Piotroski chose yes-or-no signals because they are simple to implement, and he noted they can discard information. Scoring the direction also avoids the industry problem above. He tested the score within a high book-to-market cohort, not across the whole market, which matters when reading a total computed over every listed company.
Check yourself
Company X has an asset turnover of 0.6 and Company Y has 2.4. What can you conclude?
- Company Y is the better-run business
- Nothing on its own; the figure has to be read beside each company's net margin
- Company X is carrying too much debt
Show the answer
Answer: B.
Net margin multiplied by asset turnover equals return on assets. A low turnover paired with a wide margin can produce the same return as a high turnover paired with a thin one.Two companies each pay 600 for an acquisition. For one the price is mostly goodwill; for the other, mostly customer lists amortised over five years. Whose asset turnover stays lower for longer?
- The one that recorded mostly goodwill
- The one that recorded mostly customer lists
- Neither; acquisitions do not affect turnover
Show the answer
Answer: A.
Customer lists amortise out of total assets over five years. Goodwill is not amortised, so it stays in the denominator at full value unless an impairment test fails.In Piotroski's F-score, what earns the asset turnover point?
- Turnover above its industry median
- Turnover higher than the year before
- Turnover above 1.0
Show the answer
Answer: B.
The test scores a point when this year's asset turnover beats last year's. Piotroski chose yes-or-no signals because they are simple to implement.Sources
- Piotroski, "Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers," Journal of Accounting Research, 2000.
- Financial Accounting Standards Board, ASC 350, Intangibles, Goodwill and Other.
What this leaves out
- This lesson gives no target level, and none exists that survives the differences described above. The percentile within the same industry, and the direction over time, are the only defensible readings.
- The worked figures use round invented inputs, and the three averaging conventions shown are all in published use.
- The ratio does not transfer to banks, insurers or any business whose assets are the product, and a series spanning the adoption of ASC 842 is not comparable across the transition.
- Nothing here is advice about any security.