Like a puppy chasing its tail, some new investors often chase...

Like a puppy chasing its tail, some new investors often chase ‘the next big thing’, even if that means buying ‘story stocks’ without revenue, let alone profit. But as Warren Buffett has mused, ‘If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.’ When they buy such story stocks, investors are all too often the patsy.

In the age of tech-stock blue-sky investing, my choice may seem old fashioned; I still prefer profitable companies likea2 Milk(NZSE:ATM). Even if the shares are fully valued today, most capitalists would recognize its profits as the demonstration of steady value generation. In comparison, loss making companies act like a sponge for capital – but unlike such a sponge they do not always produce something when squeezed.

View our latest analysis for a2 Milk

How Fast Is a2 Milk Growing Its Earnings Per Share?

In the last three years a2 Milk’s earnings per share took off like a rocket; fast, and from a low base. So the actual rate of growth doesn’t tell us much. Thus, it makes sense to focus on more recent growth rates, instead. Like a wedge-tailed eagle on the wind, a2 Milk’s EPS soared from NZ$0.35 to NZ$0.44, in just one year. That’s a impressive gain of 26%.

I like to see top-line growth as an indication that growth is sustainable, and I look for a high earnings before interest and taxation (EBIT) margin to point to a competitive moat (though some companies with low margins also have moats). While a2 Milk did well to grow revenue over the last year, EBIT margins were dampened at the same time. So it seems the future my hold further growth, especially if EBIT margins can stabilize.

In the chart below, you can see how the company has grown earnings, and revenue, over time. For finer detail, click on the image.

NZSE:ATM Income Statement May 2nd 2020

While we live in the present moment at all times, there’s no doubt in my mind that the future matters more than the past. So why not checkthis interactive chart depicting future EPS estimates, for a2 Milk?

Are a2 Milk Insiders Aligned With All Shareholders?

We would not expect to see insiders owning a large percentage of a NZ$14b company like a2 Milk. But we are reassured by the fact they have invested in the company. To be specific, they have NZ$72m worth of shares. That shows significant buy-in, and may indicate conviction in the business strategy. Despite being just 0.5% of the company, the value of that investment is enough to show insiders have plenty riding on the venture.

It’s good to see that insiders are invested in the company, but are remuneration levels reasonable? Well, based on the CEO pay, I’d say they are indeed. I discovered that the median total compensation for the CEOs of companies like a2 Milk with market caps between AU$6.2b and AU$19b is about AU$4.3m.

The a2 Milk CEO received total compensation of just AU$1.5m in the year to . That looks like modest pay to me, and may hint at a certain respect for the interests of shareholders. While the level of CEO compensation isn’t a huge factor in my view of the company, modest remuneration is a positive, because it suggests that the board keeps shareholder interests in mind. I’d also argue reasonable pay levels attest to good decision making more generally.

Does a2 Milk Deserve A Spot On Your Watchlist?

You can’t deny that a2 Milk has grown its earnings per share at a very impressive rate. That’s attractive. If that’s not enough, consider also that the CEO pay is quite reasonable, and insiders are well-invested alongside other shareholders. This may only be a fast rundown, but the takeaway for me is that a2 Milk is worth keeping an eye on. Of course dentifying quality businesses is only half the battle; investors need to know whether the stock is undervalued. So you might want to consider thisfreediscounted cashflow valuationof a2 Milk.