It is hard to get excited after looking at a2 Milk's (NZSE:ATM) recent performance, when its stock has declined 30% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to a2 Milk's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for a2 Milk is:
34% = NZ$388m ÷ NZ$1.1b (Based on the trailing twelve months to June 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.34 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
a2 Milk's Earnings Growth And 34% ROE
To begin with, a2 Milk has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 7.7% which is quite remarkable. Under the circumstances, a2 Milk's considerable five year net income growth of 51% was to be expected.
Next, on comparing with the industry net income growth, we found that a2 Milk's growth is quite high when compared to the industry average growth of 6.8% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is ATM fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is a2 Milk Efficiently Re-investing Its Profits?
On the whole, we feel that a2 Milk's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.