Will the market correct the stock price in the future?
With its stock down 21% in the past three months, it’s easy to overlook a2 milk (NZSE: ATM). However, the company’s fundamentals look pretty decent and long-term financial data is generally in line with future market price movements. More specifically, we decided to study a2 Milk RE in this article.
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In simpler terms, it measures a company’s profitability relative to equity.
How do you calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for a2 Milk is:
1.5% = NZ$17 million ÷ NZ$1.1 billion (based on trailing 12 months to December 2021).
“Yield” is the income the business has earned over the past year. Another way to think about this is that for every NZ$1 of 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 effective profit-generating indicator for a company’s future earnings. We now need to assess how much profit the company is reinvesting or “retaining” for future growth, which then gives us an idea of the company’s growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
a2 Milk earnings growth and ROE of 1.5%
As you can see, a2 Milk’s ROE seems quite low. Not only that, even compared to the industry average of 7.8%, the company’s ROE is quite unremarkable. a2 Dairy still saw decent net income growth of 8.0% over the past five years. Therefore, the earnings growth could likely have been caused by other variables. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio.
Then, comparing with the industry net income growth, we found that the growth of a2 Milk is quite high compared to the average industry growth of 5.3% over the same period, which which is great to see.
Earnings growth is an important factor in stock valuation. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This will help them determine if the future of the title looks bright or ominous. If you’re wondering about a2 Milk’s rating, check out this gauge of its price/earnings ratioin relation to its industry.
a2 Does Milk effectively reinvest its profits?
a2 Milk currently pays no dividends, which essentially means that it has reinvested all of its profits back into the business. This certainly contributes to the decent number of earnings growth we discussed above.
Overall, we feel a2 milk has positive attributes. Even despite the low rate of return, the company has shown impressive earnings growth thanks to massive reinvestment in its business. That said, the latest analyst forecasts show that the company will continue to see earnings expansion. For more on the latest analyst forecasts for the company, check out this visualization of analyst forecasts for the business.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.