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Record high: Why I’d prefer a2 Milk shares before Bellamy’s

The original success of baby formula merchants Bellamy’s Australia Ltd (ASX: BAL) and a2 Milk Co Australia Ltd (ASX: A2M) has spawned a lot of imitators on the local share market including the likes of Wattle Health Ltd (ASX: WHA), Bubs Australia Ltd (ASX: BUB) and even vitamins manufacturer Blackmores Limited (ASX: BKL).

However, a2 Milk is the undoubted growth king for investors with its share price up from 56 cents in April 2015 to $14.30 today to mean it has returned around 25x to any investors lucky enough to hold on for the ride.

a2 is now valued at $10.3 billion by the market and at a record high of $14.39, but for investors the only thing that now counts is the future for the stock.

For the six months ending December 31 2019 a2 Milk posted a net profit of NZ$152.7 million on revenue of NZ$613.1 million, which were up 55% and 41% respectively.

Analysts expect it to earn around 37 cents per share in fiscal 2019 to place it on 39x estimated earnings, but we can see with profit growth at 55% it’s actually on a forward price-to-earnings growth (PEG) ratio less than 1.

Famous investor Peter Lynch popularised the PEG ratio as a simple way to assess the value of growth businesses with a PEG less than 1 indicating a business could be cheap according to Lynch.

a2 Milk also has no debt and cash on hand of NZ$288 million at its last reporting date to suggest it’s not juicing its earnings growth at the expense of debt or acquisitions for example.

Another famous investor in Charlie Munger has also suggested how pricing power (or the ability to charge more than rivals, raise prices without affecting demand, etc,) is also a key attribute to look for in a long-term growth story.

Pricing power is rare and investing is not rocket science, but if you buy into the idea that a2 Milk has pricing power via its a2-only-protein product then it’s reasonable to assume the company still has a good future.

On the other hand Bellamy’s shares are down 6% to $9.32 today and remain scarily volatile over the past 5 years, although in fairness the general trend remains higher.

Bellamy’s also has close to 10% of its shares shorted, which is probably adding to the volatility.

It looks an even higher risk / return business than a2 especially considering it’s still reportedly waiting on a Chinese regulatory license. However, it’s possible Bellamy’s outperforms a2 Milk shares from here if the company gets its act together.

However,  for me the only investment grade business in the baby formula space is a2 Milk Co. If I didn’t own a small amount already, I’d happily take a small position today and look to add to it in 3 or 6 months’ time for example in order to average out my final buy price and lower the risk of bad luck in my timing.

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Motley Fool contributor Tom Richardson owns shares of A2 Milk and Blackmores Limited. The Motley Fool Australia owns shares of and has recommended Blackmores Limited. The Motley Fool Australia owns shares of A2 Milk. The Motley Fool Australia has recommended Bellamy's Australia and BUBS AUST FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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