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

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at a2 Milk (NZSE:ATM), it didn't seem to tick all of these boxes.

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What Is Return On Capital Employed (ROCE)?

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

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 .

What Can We Tell From a2 Milk's ROCE Trend?

On the surface, the trend of ROCE at a2 Milk doesn't inspire confidence. Around five years ago the returns on capital were 47%, but since then they've fallen to 14%. However it looks like a2 Milk might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On a2 Milk's ROCE

To conclude, we've found that a2 Milk is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 59% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

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 for ATM on our platform.

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.