Yahoo Finance Meridian Energy Limited's (NZSE:MEL) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?
It is hard to get excited after looking at Meridian Energy's (NZSE:MEL) recent performance, when its stock has declined 14% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Meridian Energy's ROE.
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.
View our latest analysis for Meridian Energy
How Do You Calculate Return On Equity?
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:
7.1% = NZ$378m ÷ NZ$5.3b (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.07 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learnt that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Meridian Energy's Earnings Growth And 7.1% ROE
At first glance, Meridian Energy's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 5.9% which we definitely can't overlook. This certainly adds some context to Meridian Energy's moderate 8.3% net income growth seen over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.
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 8.3% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is MEL fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Meridian Energy Using Its Retained Earnings Effectively?
The really high three-year median payout ratio of 139% for Meridian Energy suggests that the company is paying its shareholders more than what it is earning. However, this hasn't really hampered its ability to grow as we saw earlier. It would still be worth keeping an eye on that high payout ratio, if for some reason the company runs into problems and business deteriorates. Our risks dashboard should have the 3 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 five years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 195% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
Summary
On the whole, we do feel that Meridian Energy has some positive attributes. Especially the growth in earnings which was backed by a moderate ROE. Still, the ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.
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.
