Be Wary Of a2 Milk (NZSE:ATM) And Its Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think a2 Milk (NZSE:ATM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for a2 Milk:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.17 = NZ$207m ÷ (NZ$1.6b - NZ$348m) (Based on the trailing twelve months to December 2023).

So, a2 Milk has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 9.7% it's much better.

View our latest analysis for a2 Milk

roce

Above you can see how the current ROCE for a2 Milk compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for a2 Milk .

So How Is a2 Milk's ROCE Trending?

In terms of a2 Milk's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 56% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

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 in the last five years, the stock has given away 53% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you're still interested in a2 Milk it's worth checking out our FREE intrinsic value approximation for ATM to see if it's trading at an attractive price in other respects.

While a2 Milk may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com