The Returns On Capital At a2 Milk (NZSE:ATM) Don't Inspire Confidence

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at a2 Milk (NZSE:ATM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)

0.14 = NZ$177m ÷ (NZ$1.7b - NZ$440m) (Based on the trailing twelve months to June 2022).

Thus, a2 Milk has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 9.6% generated by the Food industry.

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

What Can We Tell From a2 Milk's ROCE Trend?

On the surface, the trend of ROCE at a2 Milk doesn't inspire confidence. Around five years ago the returns on capital were 58%, but since then they've fallen to 14%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On a2 Milk's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that a2 Milk is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 15% over the last five years, so there might be an opportunity here for astute investors. 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.

While a2 Milk may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.