Yahoo Finance How Good Is Meridian Energy Limited (NZSE:MEL) At Creating Shareholder Value?
Today we'll look at Meridian Energy Limited (NZSE:MEL) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Meridian Energy:
0.069 = NZ$620m ÷ (NZ$9.7b - NZ$620m) (Based on the trailing twelve months to June 2019.)
So, Meridian Energy has an ROCE of 6.9%.
See our latest analysis for Meridian Energy
Is Meridian Energy's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Meridian Energy's ROCE is fairly close to the Renewable Energy industry average of 8.0%. Aside from the industry comparison, Meridian Energy's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
In our analysis, Meridian Energy's ROCE appears to be 6.9%, compared to 3 years ago, when its ROCE was 5.0%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Meridian Energy's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Meridian Energy.
Do Meridian Energy's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Meridian Energy has total liabilities of NZ$620m and total assets of NZ$9.7b. As a result, its current liabilities are equal to approximately 6.4% of its total assets. Meridian Energy reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Meridian Energy's ROCE
Meridian Energy looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Meridian Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Meridian Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
