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There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. In light of that, when we looked at Meridian Energy (NZSE:MEL) and its ROCE trend, we weren't exactly thrilled.
Understanding 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. To calculate this metric for Meridian Energy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.053 = NZ$459m ÷ (NZ$9.4b - NZ$736m) (Based on the trailing twelve months to December 2020).
Therefore, Meridian Energy has an ROCE of 5.3%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 7.0%.
In the above chart we have measured Meridian Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Meridian Energy.
What Can We Tell From Meridian Energy's ROCE Trend?
There are better returns on capital out there than what we're seeing at Meridian Energy. Over the past five years, ROCE has remained relatively flat at around 5.3% and the business has deployed 21% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
Our Take On Meridian Energy's ROCE
In conclusion, Meridian Energy has been investing more capital into the business, but returns on that capital haven't increased. Yet to long term shareholders the stock has gifted them an incredible 152% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Meridian Energy (of which 1 is significant!) that you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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