Yahoo Finance Are The a2 Milk Company Limited's (NZSE:ATM) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?
a2 Milk (NZSE:ATM) has had a rough three months with its share price down 18%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to a2 Milk's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for a2 Milk
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for a2 Milk is:
11% = NZ$127m ÷ NZ$1.2b (Based on the trailing twelve months to December 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.11 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
a2 Milk's Earnings Growth And 11% ROE
At first glance, a2 Milk seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 9.1%. As you might expect, the 14% net income decline reported by a2 Milk is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 5.2% in the same period, we still found a2 Milk's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is ATM worth today? The intrinsic value infographic in our free research report helps visualize whether ATM is currently mispriced by the market.
Is a2 Milk Using Its Retained Earnings Effectively?
a2 Milk doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Conclusion
In total, it does look like a2 Milk has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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