Returns On Capital At a2 Milk (NZSE:ATM) Paint A Concerning Picture

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. 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.

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

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)

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

Therefore, a2 Milk has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 9.4% it's much better.

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 to see what analysts are forecasting going forward, you should check out our free report for a2 Milk.

So How Is a2 Milk's ROCE Trending?

When we looked at the ROCE trend at a2 Milk, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 15% from 55% five years ago. 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

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 49% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.