We Like a2 Milk's (NZSE:ATM) Returns And Here's How They're Trending

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Speaking of which, we noticed some great changes in a2 Milk's (NZSE:ATM) returns on capital, so let's have a look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the 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)

0.38 = NZ$458m ÷ (NZ$1.4b - NZ$199m) (Based on the trailing twelve months to December 2020).

So, a2 Milk has an ROCE of 38%. In absolute terms that's a great return and it's even better than the Food industry average of 7.7%.

View 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.

So How Is a2 Milk's ROCE Trending?

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 38%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 987%. So we're very much inspired by what we're seeing at a2 Milk thanks to its ability to profitably reinvest capital.

One more thing to note, a2 Milk has decreased current liabilities to 14% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

The Key Takeaway

In summary, it's great to see that a2 Milk can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Like most companies, a2 Milk does come with some risks, and we've found 1 warning sign that you should be aware of.

a2 Milk is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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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