With stock down 21% over the past three months, it’s easy to disregard a2 Milk (NZSE:ATM). However, the company’s fundamentals look pretty decent, and long-term financials are usually biased towards future market price movements. Specifically, we decided to study a2 milk ROE in this article.
Return on equity, or ROE, is a test of how effectively a company is increasing its value and managing investors’ money. Put simply, it measures a company’s profitability in relation to its equity.
How do you calculate return on equity?
The return on equity can be calculated using the following formula:
Return on Equity = Net Income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for a2 milk is:
1.5% = NZ$17m ÷ NZ$1.1bn (Based on trailing 12 months to December 2021).
The “return” is the income that the company has made in the last year. Another way to think of it is that for every NZ$1 in equity, the company was able to make a profit of NZ$0.01.
Why is ROE important for earnings growth?
We have already established that ROE serves as an efficient profitable measure of a company’s future profits. We now need to evaluate how much profit the company is reinvesting or “keeping” for future growth, which then gives us an idea of the company’s growth potential. In general, companies with a high return on equity and earnings retention, all other things being equal, have a higher growth rate than companies that do not share these characteristics.
a2 Milk yield growth and 1.5% ROE
As you can see, a2 Milk’s ROE looks pretty weak. Not only that, even compared to the industry average of 7.8%, the company’s ROE is completely unremarkable. a2 Milk has still had decent net income growth of 8.0% over the last five years. Therefore, earnings growth could likely have been caused by other variables. For example, it’s possible that the company’s management has made some good strategic decisions, or that the company has a low payout ratio.
Next, when comparing the industry net income growth, we found that a2 Milk’s growth is quite high compared to the average industry growth of 5.3% over the same period, which is great to see.
Earnings growth is an important factor in stock valuation. Next, investors need to determine whether expected earnings growth, or lack of it, is already embedded in the stock price. This allows them to determine if the stock’s future looks bright or ominous. If you are wondering about a2 Milk’s rating, check this out this measure of the price-to-earnings ratiocompared to its industry.
Does a2 Milk reinvest its profits efficiently?
a2 Milk doesn’t currently pay a dividend, which essentially means it has reinvested all of its profits into the company. This definitely contributes to the decent earnings growth we discussed above.
Overall we feel that a2 Milk has some positive attributes. Despite the low yield, the company has delivered impressive earnings growth as it has heavily reinvested in its business. Against this background, the latest analyst forecasts show that the company will continue to increase its profits. You can read more about the latest analyst forecasts for the company here Visualization of analyst forecasts for the company.
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This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.