The 48% Return On Capital At a2 Milk (NZSE:ATM) Got Our Attention

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at the ROCE trend of a2 Milk (NZSE:ATM) we really liked what we saw.

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. To calculate this metric for a2 Milk, this is the formula:

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

0.48 = NZ$548m ÷ (NZ$1.5b - NZ$305m) (Based on the trailing twelve months to June 2020).

Therefore, a2 Milk has an ROCE of 48%. In absolute terms that's a great return and it's even better than the Food industry average of 7.1%.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

The trends we've noticed at a2 Milk are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 48%. The amount of capital employed has increased too, by 1,782%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a related note, the company's ratio of current liabilities to total assets has decreased to 21%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Key Takeaway

All in all, it's terrific to see that a2 Milk is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if a2 Milk can keep these trends up, it could have a bright future ahead.

If you'd like to know about the risks facing a2 Milk, we've discovered 1 warning sign that you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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This article by Simply Wall St is general in nature. 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.
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