Yahoo Finance Meridian Energy Limited (NZSE:MEL) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?
Meridian Energy (NZSE:MEL) has had a great run on the share market with its stock up by a significant 17% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Meridian Energy's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Meridian Energy
How To Calculate Return On Equity?
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:
3.5% = NZ$176m ÷ NZ$5.1b (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.03 in profit.
Why Is ROE Important For 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Meridian Energy's Earnings Growth And 3.5% ROE
It is quite clear that Meridian Energy's ROE is rather low. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 3.1%. So we are actually pleased to see that Meridian Energy's net income grew at an acceptable rate of 7.5% over the last five years. We reckon that there could also be other factors at play that are influencing the company's growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Meridian Energy's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 8.9% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Meridian Energy is trading on a high P/E or a low P/E, relative to its industry.
Is Meridian Energy Making Efficient Use Of Its Profits?
Meridian Energy has a very high three-year median payout ratio of 167% suggesting that the company's shareholders are getting paid from more than just the company's earnings. However, this hasn't really hampered its ability to grow as we saw earlier. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates. You can see the 2 risks we have identified for Meridian Energy by visiting our risks dashboard for free on our platform here.
Additionally, Meridian Energy has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 218% over the next three years. However, Meridian Energy's future ROE is expected to rise to 5.4% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.
Conclusion
In total, we're a bit ambivalent about Meridian Energy's performance. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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