Meridian Energy's (NZSE:MEL) Returns Have Hit A Wall

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Meridian Energy (NZSE:MEL), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Meridian Energy is:

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

0.053 = NZ$459m ÷ (NZ$9.4b - NZ$736m) (Based on the trailing twelve months to December 2020).

Therefore, Meridian Energy has an ROCE of 5.3%. Even though it's in line with the industry average of 5.3%, it's still a low return by itself.

See our latest analysis for Meridian Energy

Above you can see how the current ROCE for Meridian Energy compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

There are better returns on capital out there than what we're seeing at Meridian Energy. The company has consistently earned 5.3% for the last five years, and the capital employed within the business has risen 21% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

The Key Takeaway

Long story short, while Meridian Energy has been reinvesting its capital, the returns that it's generating haven't increased. Yet to long term shareholders the stock has gifted them an incredible 123% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Meridian Energy (of which 1 makes us a bit uncomfortable!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
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