Yahoo Finance Some Investors May Be Worried About a2 Milk's (NZSE:ATM) Returns On Capital
To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at a2 Milk (NZSE:ATM) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for a2 Milk, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = NZ$40m ÷ (NZ$1.6b - NZ$387m) (Based on the trailing twelve months to December 2021).
So, a2 Milk has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Food industry average of 7.0%.
Check out our latest analysis for a2 Milk
In the above chart we have measured a2 Milk's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for a2 Milk.
The Trend Of ROCE
In terms of a2 Milk's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.3% from 57% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
Our Take On a2 Milk's ROCE
We're a bit apprehensive about a2 Milk because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 62% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Like most companies, a2 Milk does come with some risks, and we've found 2 warning signs that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
