130 ShowMetheMoney
Return on assets is thus the toughest measure of performance
base don returns, as it reveals the results of deploying all the assets
at management’s disposal. Starting with a high return on assets
shoul dyiel da high return on investment an dhence on equity. (Some
analysts calculate a “financial leverage index” equal to the return on
equity divided by the return on assets.)
Higher returns on assets are achieve dby squeezing earnings out
of fewer or smaller asset bases. Microsoft starts off with a return on
assets of 25%, suggesting a relatively low level of asset intensity,
freeing it from dependency on debt and enabling it to generate re-
turns on equity of nearly 10 points more. At the other extreme, GE
starts off with a return on assets of just 3%, meaning it must manage
its capital structure to use debt skillfully and deploy assets efficiently
in order to get the higher returns on equity of about 27% that it
achieves.
Microsoft is asset-nonintensive, whereas GE is quite asset-
intensive. The earnings of many companies (Amazon.com maybe)
are driven by brand names and/or inventory and distribution systems
far more than by the plants an dother physical resources that make
up their balance sheet assets. Microsoft relies more on fixe dan d
other assets but also is able to extract prodigious earnings from its
bran dname an dmarket position. GE’s asset-intensive business re-
quires heavy investment in plants an dequipment even as its pro d-
ucts enjoy enormous bran drecognition (“We bring goo dthings to
life”).
It is too soon to tell how Amazon.com will fare in the contest
for high returns on assets. Certainly its business model is designed
to minimize asset intensity. Its bran dname an dInternet presence
are the key drivers of sales and hence earnings. It minimizes its fixed
asset needs by avoiding the bricks-and-mortar store operations to
which Barnes & Noble and other traditional retailers devote re-
sources.
Amazon.com’s just-in-time inventory management is designed to
reduce the carrying costs of inventory. Its trade terms with customers
an dsuppliers drive incremental earnings by superior short-term
working capital management—it receives revenues from customers
as products are ordered but usually need not pay its suppliers for
those goods until some 30 to 60 days later. Internet customers base
purchases on pictures an dimages on the Internet screen, moreover,
meaning Amazon.com does not suffer from books damaged by cus-
tomers thumbing through them. Bricks-and-mortar bookstores incur