The a2 Milk Company Ltd (ASX: A2M) share price has been battered lately, down nearly 27% over the last three months following uncertainty about China. Here are two reasons I still like a2 Milk shares.
About a2 Milk
The a2 Milk Company is one of Australia and New Zealand’s largest infant formula producers and the leader in a2-only protein-based dairy products. It has operations in New Zealand, Australia, USA and China thanks to crucial supply and distribution agreements.
Why I Like a2 Milk Shares
It would be easy to say something like “they are growing quickly” or “there is a big market opportunity in China” but those are obvious reasons. There are two things I always look for in an investment and a2 Milk ticks both of these boxes.
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Zero Long-Term Debt
One of the first things I look for in a company is low, or preferably zero, long-term debt. I like to see that a company is not relying on leverage and that, if it has any debt, it can be easily covered by cash flows.
There are a few reasons for this. The first obvious reason is safety. In the most general sense, a company with high levels of debt is more likely to run into trouble then a company with no debt.
It also comes down to incentives. It should always be remembered that companies have two options for raising money – equity or debt. I won’t go into it too much here, but debt and equity holders have different incentives and priorities. Equity holders want the company to maximise returns, whereas debt holders want the company to be conservative and minimise risk.
So, having large amounts of debt can alter the incentives and priorities of the company in a way that negatively impacts equity holders.
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Return on Equity (ROE)
Another thing I always look for is a high ROE, usually above 20%. The a2 Milk Company’s ROE has been over 35% for the last three years, meaning (this is a very basic description) they can take $1 of equity and turn it into $1.35.
The following Rask Finance video explains Return On Investment (ROI), which is similar to ROE:
At 35%, a2 Milk’s ROE is the sort of return that any investor would be happy with. While high returns on equity don’t directly correlate to high share price appreciation, it’s a clear sign that the company knows how to effectively invest its capital in projects that create value.
If there’s one thing to focus on for a long-term investment, it’s how much value can a company create.
Is a2 Milk A Buy?
I’m not saying I would buy a2 Milk shares today, as the price does still seem reasonably high. What I’m saying though is try not to get caught up in all the news of trade wars and analyst estimates (read guesses). The company has very high growth, a high ROE and no debt. No matter what happens with China, this is a good company.
For other high-growth shares, check out the free report below.
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Disclosure: At the time of writing, Max does not own shares in any of the companies mentioned.
