Is Meridian Energy Limited's (NZSE:MEL) Stock On A Downtrend As A Result Of Its Poor Financials?

It is hard to get excited after looking at Meridian Energy's (NZSE:MEL) recent performance, when its stock has declined 4.6% over the past three months. 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. In this article, we decided to focus on Meridian Energy's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How Is ROE Calculated?

ROE 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:

1.5% = NZ$117m ÷ NZ$7.8b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.01 in profit.

View our latest analysis for Meridian Energy

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Meridian Energy's Earnings Growth And 1.5% ROE

As you can see, Meridian Energy's ROE looks pretty weak. Even compared to the average industry ROE of 12%, the company's ROE is quite dismal. For this reason, Meridian Energy's five year net income decline of 5.5% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 0.9% in the same 5-year period, we still found Meridian Energy's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Meridian Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Meridian Energy Efficiently Re-investing Its Profits?

With a three-year median payout ratio as high as 174%,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 higher than reported profits is not a sustainable move.

Moreover, Meridian Energy has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 146%. Still, forecasts suggest that Meridian Energy's future ROE will rise to 6.7% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we would be extremely cautious before making any decision on Meridian Energy. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.