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The a2 Milk Company Limited (NZSE:ATM) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

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·3 min read
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With its stock down 21% over the past three months, it is easy to disregard a2 Milk (NZSE:ATM). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study a2 Milk's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for a2 Milk

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

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

1.5% = NZ$17m ÷ NZ$1.1b (Based on the trailing twelve months to December 2021).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.01 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

a2 Milk's Earnings Growth And 1.5% ROE

As you can see, a2 Milk's ROE looks pretty weak. Not just that, even compared to the industry average of 7.8%, the company's ROE is entirely unremarkable. a2 Milk was still able to see a decent net income growth of 8.0% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that a2 Milk's growth is quite high when compared to the industry average growth of 5.3% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Efficiently Re-investing Its Profits?

a2 Milk doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the decent earnings growth number that we discussed above.

Conclusion

On the whole, we do feel that a2 Milk has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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

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.