Be Wary Of Meridian Energy (NZSE:MEL) And Its Returns On Capital

What financial metrics can indicate to us that a company is maturing or even in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Meridian Energy (NZSE:MEL), so let's see why.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Meridian Energy, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.018 = NZ$168m ÷ (NZ$10b - NZ$1.0b) (Based on the trailing twelve months to December 2023).

Thus, Meridian Energy has an ROCE of 1.8%. Even though it's in line with the industry average of 1.8%, it's still a low return by itself.

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'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Meridian Energy .

What Does the ROCE Trend For Meridian Energy Tell Us?

In terms of Meridian Energy's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 5.9% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Meridian Energy becoming one if things continue as they have.

Our Take On Meridian Energy's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 74% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know about the risks facing Meridian Energy, we've discovered 1 warning sign that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.