Most readers would already know that Meridian Energy's (NZSE:MEL) stock increased by 2.8% over the past week. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Specifically, we decided to study Meridian Energy's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Meridian Energy

How Do You Calculate Return On Equity?

ROE 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:

5.2% = NZ$429m ÷ NZ$8.2b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 5.2% ROE

When you first look at it, Meridian Energy's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 8.9%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 3.3% seen by Meridian Energy was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

As a next step, we compared Meridian Energy's performance with the industry and discovered the industry has shrunk at a rate of 16% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. While this is not particularly good, its not particularly bad either.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Meridian Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Meridian Energy Efficiently Re-investing Its Profits?

Meridian Energy's very high three-year median payout ratio of 129% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term.

Additionally, Meridian Energy has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 132%. Still, forecasts suggest that Meridian Energy's future ROE will rise to 6.2% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we would be extremely cautious before making any decision on Meridian Energy. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.