Most readers would already be aware that Meridian Energy's (NZSE:MEL) stock increased significantly by 13% over the past three months. 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.
How Do You Calculate Return On Equity?
Return on equity 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:
8.2% = NZ$451m ÷ NZ$5.5b (Based on the trailing twelve months to June 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Meridian Energy's Earnings Growth And 8.2% ROE
At first glance, Meridian Energy's ROE doesn't look very promising. However, its ROE is similar to the industry average of 9.5%, so we won't completely dismiss the company. Even so, Meridian Energy has shown a fairly decent growth in its net income which grew at a rate of 14%. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Meridian Energy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.
Earnings growth is an important metric to consider when valuing a stock. 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 Meridian Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Meridian Energy Efficiently Re-investing Its Profits?
Meridian Energy's high three-year median payout ratio of 125% suggests that the company is paying out more to its shareholders than what it is making. Still the company's earnings have grown respectably. 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 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 138% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 7.2%.
Overall, we have mixed feelings about Meridian Energy. While no doubt its earnings growth is pretty substantial, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, especially during troubled times. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
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