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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Meridian Energy (NZSE:MEL) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Meridian Energy:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = NZ$650m ÷ (NZ$9.6b - NZ$583m) (Based on the trailing twelve months to December 2019).
So, Meridian Energy has an ROCE of 7.2%. Even though it's in line with the industry average of 7.2%, it's still a low return by itself.
In the above chart we have a measured Meridian Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Meridian Energy here for free.
So How Is Meridian Energy's ROCE Trending?
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The data shows that returns on capital have increased substantially over the last five years to 7.2%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 27%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line
To sum it up, Meridian Energy has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these trends are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Meridian Energy can keep these trends up, it could have a bright future ahead.
On a final note, we've found 2 warning signs for Meridian Energy that we think you should be aware of.
While Meridian Energy may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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