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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Meridian Energy (NZSE:MEL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its 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)
0.054 = NZ$673m ÷ (NZ$14b - NZ$1.0b) (Based on the trailing twelve months to June 2024).
Therefore, Meridian Energy has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 8.7%.
View our latest analysis for Meridian Energy
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, you can check out the forecasts from the analysts covering Meridian Energy for free.
What The Trend Of ROCE Can Tell Us
In terms of Meridian Energy's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 6.9%, but since then they've fallen to 5.4%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
In Conclusion...
In summary, despite lower returns in the short term, we're encouraged to see that Meridian Energy is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 35% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
If you want to continue researching Meridian Energy, you might be interested to know about the 1 warning sign that our analysis has discovered.