a2 Milk (NZSE:ATM) Will Want To Turn Around Its Return Trends

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. In light of that, when we looked at a2 Milk (NZSE:ATM) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. Analysts use this formula to calculate it for a2 Milk:

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

0.16 = NZ$201m ÷ (NZ$1.6b - NZ$379m) (Based on the trailing twelve months to June 2023).

Thus, a2 Milk has an ROCE of 16%. That's a pretty standard return and it's in line with the industry average of 16%.

See 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'd like, you can check out the forecasts from the analysts covering a2 Milk here for free.

What Does the ROCE Trend For a2 Milk Tell Us?

In terms of a2 Milk's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 50%, but since then they've fallen to 16%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On a2 Milk's ROCE

While returns have fallen for a2 Milk in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 59% 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.

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

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.