This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Akamai Technologies, Inc.'s (NASDAQ:AKAM) P/E ratio could help you assess the value on offer. What is Akamai Technologies's P/E ratio? Well, based on the last twelve months it is 34.91. That corresponds to an earnings yield of approximately 2.9%.
How Do You Calculate Akamai Technologies's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Akamai Technologies:
P/E of 34.91 = $90.02 ÷ $2.58 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Akamai Technologies Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Akamai Technologies has a P/E ratio that is roughly in line with the it industry average (34.9).
Akamai Technologies's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, Akamai Technologies grew EPS like Taylor Swift grew her fan base back in 2010; the 133% gain was both fast and well deserved. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 12%.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Akamai Technologies's P/E?
The extra options and safety that comes with Akamai Technologies's US$149m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Akamai Technologies's P/E Ratio
Akamai Technologies's P/E is 34.9 which is above average (18.0) in its market. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Akamai Technologies. So you may wish to see this free collection of other companies that have grown earnings strongly.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.