What Should Investors Know About The a2 Milk Company Limited's (NZSE:ATM) Return On Capital?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in The a2 Milk Company Limited (NZSE:ATM).

Buying a2 Milk makes you a partial owner of the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Therefore, looking at how efficiently a2 Milk is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.

Check out our latest analysis for a2 Milk

What is Return on Capital Employed (ROCE)?

Choosing to invest in a2 Milk comes at the cost of investing in another potentially favourable company. Accordingly, before you invest you need to assess the capital returns that the company has produced with reference to a certain benchmark to ensure that you are confident in the business' ability to grow your capital at a level that grants an investment over other companies. To determine a2 Milk's capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). ATM’s ROCE is calculated below:

As you can see, ATM earned NZ$56.3 from every NZ$100 you invested over the previous twelve months. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by ATM and means the company creates an excellent amount of earnings on capital employed. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound extremely well over time.

Before moving forward

a2 Milk's relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment a2 Milk is in a favourable position, but this can change if these factors underperform. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. If you go back three years, you'll find that ATM’s ROCE has increased from 4.41%. With this, the current earnings of NZ$219.27m improved from NZ$2.56m and the amount of capital employed also grew but by a proportionally lesser volume, which suggests the larger ROCE is due to a growth in earnings relative to capital requirements.

Next Steps

ROCE for ATM investors has grown in the last few years and is currently at a level that makes the company an attractive candidate that is capable of producing solid capital returns, and hence, an attractive return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. Without considering these fundamentals, you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. a2 Milk's fundamentals can be explored with the links I've provided below if you are interested, otherwise you can start looking at other high-performing stocks.

1. Future Outlook: What are well-informed industry analysts predicting for ATM’s future growth? Take a look at our free research report of analyst consensus for ATM’s outlook.
2. Valuation: What is ATM worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ATM is currently mispriced by the market.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.