With its stock down 6.1% over the past month, it is easy to disregard Meridian Energy (NZSE:MEL). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Meridian Energy's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Meridian Energy is:
6.7% = NZ$346m ÷ NZ$5.1b (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.07.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 6.7% ROE
On the face of it, Meridian Energy's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.5% either. However, the moderate 12% net income growth seen by Meridian Energy over the past five years is definitely a positive. We reckon that there could be other factors at play here. 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.
Next, on comparing with the industry net income growth, we found that Meridian Energy's growth is quite high when compared to the industry average growth of 10.0% in the same period, which is great to see.
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. If you're wondering about Meridian Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Meridian Energy Making Efficient Use Of Its Profits?
Meridian Energy has a very high three-year median payout ratio of 136% suggesting that the company's shareholders are getting paid from more than just the company's earnings. Still the company's earnings have grown respectably. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum. Our risks dashboard should have the 2 risks we have identified for Meridian Energy.
Moreover, Meridian Energy is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 170% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
Overall, we have mixed feelings about Meridian Energy. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.