I am writing today to help inform people who are new to the stock market and want to begin learning the link between A2A SpA (BIT:A2A)’s return fundamentals and stock market performance.
If you purchase a A2A share you are effectively becoming a partner with many other shareholders. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently A2A is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
Calculating Return On Capital Employed for A2A
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if A2A is good at growing investor capital. I have calculated A2A’s ROCE for you below:
ROCE Calculation for A2A
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = €618m ÷ (€9.8b – €2.2b) = 8.1%
The calculation above shows that A2A’s earnings were 8.1% of capital employed. This makes A2A unattractive when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital will be able to compound over time, but not to the extent investors should be aiming for.
Why is this the case?
A2A’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment A2A is in an adverse position, but this can change if these factors improve. Because of this, it is important to look beyond the final value of A2A’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that A2A boosted investor return on capital employed from 5.0%. Similarly, the movement in the earnings variable shows a jump from €409m to €618m whilst the amount of capital employed has decreased due to a greater amount of current liabilities used (meaning the company has used more borrowed money than shareholder capital to produce earnings) , which is an indication that A2A has increased the ROCE for investors by producing more earnings and using less capital.
ROCE for A2A investors is below the desired level at the moment, however, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation to determine if an opportunity exists that isn’t made apparent by looking at past data. A2A’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for A2A’s future growth? Take a look at our free research report of analyst consensus for A2A’s outlook.
- Valuation: What is A2A worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether A2A is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.