Are Poor Financial Prospects Dragging Down Meridian Energy Limited (NZSE:MEL Stock?

Meridian Energy (NZSE:MEL) has had a rough three months with its share price down 10%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Meridian Energy's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Meridian Energy

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Meridian Energy is:

5.2% = NZ$429m ÷ NZ$8.2b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.05.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Meridian Energy's Earnings Growth And 5.2% ROE

On the face of it, Meridian Energy's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.9% either. Therefore, it might not be wrong to say that the five year net income decline of 3.3% seen by Meridian Energy was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

We then compared Meridian Energy's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 16% in the same 5-year period. This does offer shareholders some relief

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Meridian Energy is trading on a high P/E or a low P/E, relative to its industry.

Is Meridian Energy Making Efficient Use Of Its Profits?

With a three-year median payout ratio as high as 129%,Meridian Energy's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend beyond their means is usually not viable over the long term.

Additionally, Meridian Energy has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 132%. However, Meridian Energy's ROE is predicted to rise to 6.2% despite there being no anticipated change in its payout ratio.

Summary

On the whole, Meridian Energy's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.