a2 Milk (NZSE:ATM) May Have Issues Allocating Its Capital

Yahoo

3 days ago

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at a2 Milk (NZSE:ATM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on a2 Milk is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = NZ$202m ÷ (NZ$1.9b - NZ$474m) (Based on the trailing twelve months to December 2024).
Therefore, a2 Milk has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 9.6% generated by the Food industry.
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're interested, you can view the analysts predictions in our free analyst report for a2 Milk .
When we looked at the ROCE trend at a2 Milk, we didn't gain much confidence. Around five years ago the returns on capital were 47%, but since then they've fallen to 14%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Bringing it all together, while we're somewhat encouraged by a2 Milk's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 52% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
If you're still interested in a2 Milk it's worth checking out our to see if it's trading at an attractive price in other respects.
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.