The a2 Milk Company Limited's (NZSE:ATM) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at a2 Milk's (NZSE:ATM) recent performance, when its stock has declined 30% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on a2 Milk's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for a2 Milk

How Is ROE Calculated?

The formula for ROE is:

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

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

34% = NZ$388m ÷ NZ$1.1b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.34 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of a2 Milk's Earnings Growth And 34% ROE

Firstly, we acknowledge that a2 Milk has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 7.7% which is quite remarkable. As a result, a2 Milk's exceptional 51% net income growth seen over the past five years, doesn't come as a surprise.

We then compared a2 Milk's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.9% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about a2 Milk's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is a2 Milk Using Its Retained Earnings Effectively?

Summary

In total, we are pretty happy with a2 Milk's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

If you’re looking to trade a2 Milk, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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