The Returns At Meridian Energy (NZSE:MEL) Aren't Growing

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 investigating Meridian Energy (NZSE:MEL), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Meridian Energy:

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%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.3%.

View 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, you can check out the forecasts from the analysts covering Meridian Energy here for free.

The Trend Of ROCE

In terms of Meridian Energy's historical ROCE trend, it doesn't exactly demand attention. The company has employed 21% more capital in the last five years, and the returns on that capital have remained stable at 5.3%. 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.

In Conclusion...

As we've seen above, Meridian Energy's returns on capital haven't increased but it is reinvesting in the business. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 163% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Meridian Energy does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is significant...

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.

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This article by Simply Wall St is general in nature. 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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