Here's why you should keep an eye on A2 Milk (ASX:A2M)'s medium term share price

Here's why you should keep an eye on A2 Milk (ASX:A2M)'s medium term share price

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Given widespread disruption and uncertainty in the stock market, it is more important than ever to identify high quality stocks for your portfolio. This means safe, profitable companies with strong balance sheets.

When it comes to investing, I'm convinced it pays to buy and hold the best quality companies possible. These companies can compound investment returns at consistently above-average rates over the long term.

These stocks are different because they've got what billionaire investor Warren Buffett, calls economic moats.

In this article, I'm going to tell you what makes these stocks so special by using A2 Milk (ASX:A2M) as an example. A2 Milk is a balanced, large cap in the Food Processing industry.

Has A2 Milk (ASX:A2M) got a moat?

When it comes to searching for companies with moats, some of the biggest clues actually lie in their financial statements. By looking at a small number of important ratios you can get an idea about the competitive strength and profit power in a business.

Here's what they are and why they are important - and how A2 Milk stacks up against them:

  1. High rates of Free Cash Flow - the measure of a thriving company.
    - A high ratio of free cash flow to sales can be a very positive sign. For A2 Milk, the figure is an impressive 22.4%.
  2. High Return on Capital Employed - the measure of a company growing efficiently and profitably.
    - A 5-year average ROCE of more than 12 percent is a pointer to strong efficiency. For A2 Milk, the figure is an eye-catching 40.5%.
  3. High Return on Equity (compared to peers) - the measure of a company making good profits from its assets.
    - A2 Milk has a 5-year average ROE of 33.7%.
  4. High Operating Margins (compared to peers) - the measure of a company with pricing power
    - A2 Milk has a 5-year average operating margin of 20.7%.

So it does seem as though A2 Milk might have some kind of economic moat. A quick look at A2 Milk's (ASX:A2M) StockReport page shows that the company has a Quality Rank of 98.


What does this mean for potential investors?

Some of the best quality stocks in the market have defensible models that can deliver high levels of shareholder returns over the long term. But there are no guarantees and it's important to do your own research. Indeed, we've identified some areas of concern with A2 Milk that you can find out about here.


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A2 Milk's StockRank™

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A2 Milk's StockRank™

With a StockRank of 92, A2 Milk is more attractive than 92% of the 1,900 stocks we cover in Australasia, according to our proprietary ranking system.

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