Do return ratios always present the true picture?

An important indicator of the attractiveness of a company's business is shareholders return or Return on Networth (RONW). 

RONW = PAT/Networth 

Here the networth or shareholder's fund is the sum of share capital and reserves held by a company. 

However, the shareholder's returns do not always present a true and fair picture. This happens when the company has large amounts of goodwill or brand value sitting on its books on account of acquisitions made in the past. As a good accounting practice, goodwill and brands should be amortized as quickly as possible and during the period over which the benefits would accrue. But many times, the amortization is extended over longer time periods by companies to avoid margins getting hit substantially. The margin impact gets limited in such cases. But the presence of large amounts of goodwill drags down the shareholder's returns. 

Value investor, Warren Buffett, was of the view that assets like goodwill are historical costs and in no way affect the normal operations of the business. According to him, goodwill should be ignored and only net tangible assets should be considered while calculating key ratios. Therefore in such cases, it makes more sense to consider shareholder's return excluding intangible assets like goodwill to study the overall business efficiency. 

RONW = PAT/ (Networth - Intangible Assets) 

Even in case of businesses generating huge cash, the shareholder's returns get suppressed. In such cases it is advisable to look at Return on Invested Capital (ROIC) to study business profitability. This return ratio excludes the impact of cash and is defined as, 

ROIC = EBIT * (1-tax rate)/ (Total assets - Cash - Investments - Current Liabilities) 

Thus while the RONW is an important parameter in evaluating the business model of a company, it suffers from drawbacks that can be easily avoided as discussed above.