a2 Milk (NZSE:ATM) Could Be Struggling To Allocate Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.15 = NZ$187m ÷ (NZ$1.7b - NZ$415m) (Based on the trailing twelve months to December 2022).

Thus, a2 Milk has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 9.7% it's much better.

See 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 report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at a2 Milk doesn't inspire confidence. Around five years ago the returns on capital were 55%, but since then they've fallen to 15%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On a2 Milk's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for a2 Milk. These growth trends haven't led to growth returns though, since the stock has fallen 48% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

While a2 Milk doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.