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With An ROE Of 3.67%, Has Meridian Energy Limited’s (NZSE:MEL) Management Done Well?

This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Meridian Energy Limited (NZSE:MEL)’s return fundamentals and stock market performance.

Meridian Energy Limited (NZSE:MEL) generated a below-average return on equity of 3.67% in the past 12 months, while its industry returned 6.96%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into MEL’s past performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of MEL’s returns. Check out our latest analysis for Meridian Energy

Breaking down Return on Equity

Return on Equity (ROE) weighs Meridian Energy’s profit against the level of its shareholders’ equity. For example, if the company invests NZ$1 in the form of equity, it will generate NZ$0.037 in earnings from this. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.

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Return on Equity = Net Profit ÷ Shareholders Equity

ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Meridian Energy, which is 9.01%. Given a discrepancy of -5.34% between return and cost, this indicated that Meridian Energy may be paying more for its capital than what it’s generating in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

Dupont Formula

ROE = profit margin × asset turnover × financial leverage

ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)

ROE = annual net profit ÷ shareholders’ equity

NZSE:MEL Last Perf June 21st 18
NZSE:MEL Last Perf June 21st 18

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Meridian Energy can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be inflated by excessive debt, we need to examine Meridian Energy’s debt-to-equity level. At 28.66%, Meridian Energy’s debt-to-equity ratio appears low and indicates that Meridian Energy still has room to increase leverage and grow its profits.

NZSE:MEL Historical Debt June 21st 18
NZSE:MEL Historical Debt June 21st 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Meridian Energy exhibits a weak ROE against its peers, as well as insufficient levels to cover its own cost of equity this year. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Meridian Energy’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Meridian Energy, there are three important factors you should further examine:

  1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

  2. Valuation: What is Meridian Energy worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Meridian Energy is currently mispriced by the market.

  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Meridian Energy? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!


To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.