Capital Allocation Trends At Meridian Energy (NZSE:MEL) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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).

So, Meridian Energy has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 8.7%.

Check out our latest analysis for Meridian Energy

Above you can see how the current ROCE for Meridian Energy compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Meridian Energy .

What Does the ROCE Trend For Meridian Energy Tell Us?

In terms of Meridian Energy's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.4% from 6.9% five years ago. 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. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Meridian Energy's ROCE

While returns have fallen for Meridian Energy in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 60% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Meridian Energy does have some risks though, and we've spotted 1 warning sign for Meridian Energy that you might be interested in.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.