Has The a2 Milk Company Limited's (NZSE:ATM) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

a2 Milk's (NZSE:ATM) stock is up by a considerable 27% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study a2 Milk's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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How To Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for a2 Milk is:

13% = NZ$192m ÷ NZ$1.4b (Based on the trailing twelve months to June 2025).

The 'return' is the profit over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.13 in profit.

View our latest analysis for a2 Milk

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

a2 Milk's Earnings Growth And 13% ROE

To begin with, a2 Milk seems to have a respectable ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Needless to say, we are quite surprised to see that a2 Milk's net income shrunk at a rate of 8.1% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 2.2% in the same 5-year period, we still found a2 Milk's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is ATM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is a2 Milk Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 45% (that is, a retention ratio of 55%), the fact that a2 Milk's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Only recently, a2 Milk stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 75% over the next three years. Still, forecasts suggest that a2 Milk's future ROE will rise to 22% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we feel that a2 Milk certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.