There Are Reasons To Feel Uneasy About Meridian Energy's (NZSE:MEL) Returns On Capital
What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Meridian Energy (NZSE:MEL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Meridian Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = NZ$272m ÷ (NZ$13b - NZ$872m) (Based on the trailing twelve months to December 2024).
So, Meridian Energy has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 11%.
See our latest analysis for Meridian Energy
In the above chart we have measured Meridian Energy's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Meridian Energy .
On the surface, the trend of ROCE at Meridian Energy doesn't inspire confidence. To be more specific, ROCE has fallen from 7.2% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
While returns have fallen for Meridian Energy in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 43% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
On a separate note, we've found 1 warning sign for Meridian Energy you'll probably want to know about.
While Meridian Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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