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

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. 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.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on a2 Milk is:

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%. On its own, that's a standard return, however it's much better than the 11% 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'd like to see what analysts are forecasting going forward, you should check out our free analyst report for a2 Milk .

The Trend Of ROCE

On the surface, the trend of ROCE at a2 Milk doesn't inspire confidence. Around five years ago the returns on capital were 56%, but since then they've fallen to 17%. 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'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.

In Conclusion...

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 62% so the market doesn't look too hopeful on these trends strengthening any time soon. 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 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.