U.S. Markets closed
  • S&P 500

    3,310.11
    +39.08 (+1.19%)
     
  • Dow 30

    26,659.11
    +139.16 (+0.52%)
     
  • Nasdaq

    11,185.59
    +180.72 (+1.64%)
     
  • Russell 2000

    1,561.58
    +18.30 (+1.19%)
     
  • Crude Oil

    36.19
    +0.02 (+0.06%)
     
  • Gold

    1,868.50
    +0.50 (+0.03%)
     
  • Silver

    23.37
    +0.01 (+0.04%)
     
  • EUR/USD

    1.1678
    -0.0071 (-0.6073%)
     
  • 10-Yr Bond

    0.8350
    +0.0540 (+6.91%)
     
  • Vix

    37.59
    -2.69 (-6.68%)
     
  • GBP/USD

    1.2930
    -0.0057 (-0.4422%)
     
  • USD/JPY

    104.5580
    +0.2570 (+0.2464%)
     
  • BTC-USD

    13,449.52
    -93.40 (-0.69%)
     
  • CMC Crypto 200

    264.05
    +21.37 (+8.80%)
     
  • FTSE 100

    5,581.75
    -1.05 (-0.02%)
     
  • Nikkei 225

    23,331.94
    -86.57 (-0.37%)
     

Read This Before Judging Akamai Technologies, Inc.'s (NASDAQ:AKAM) ROE

Simply Wall St

Many investors are still learning about the various metrics that can be useful when analysing a stock. This article is for those who would like to learn about Return On Equity (ROE). We'll use ROE to examine Akamai Technologies, Inc. (NASDAQ:AKAM), by way of a worked example.

Akamai Technologies has a ROE of 13%, based on the last twelve months. One way to conceptualize this, is that for each $1 of shareholders' equity it has, the company made $0.13 in profit.

See our latest analysis for Akamai Technologies

How Do I Calculate ROE?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

Or for Akamai Technologies:

13% = US$453m ÷ US$3.5b (Based on the trailing twelve months to September 2019.)

It's easy to understand the 'net profit' part of that equation, but 'shareholders' equity' requires further explanation. It is the capital paid in by shareholders, plus any retained earnings. You can calculate shareholders' equity by subtracting the company's total liabilities from its total assets.

What Does Return On Equity Mean?

ROE looks at the amount a company earns relative to the money it has kept within the business. The 'return' is the yearly profit. That means that the higher the ROE, the more profitable the company is. So, all else being equal, a high ROE is better than a low one. That means ROE can be used to compare two businesses.

Does Akamai Technologies Have A Good Return On Equity?

One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. If you look at the image below, you can see Akamai Technologies has a lower ROE than the average (18%) in the IT industry classification.

NasdaqGS:AKAM Past Revenue and Net Income, December 30th 2019
NasdaqGS:AKAM Past Revenue and Net Income, December 30th 2019

That certainly isn't ideal. We'd prefer see an ROE above the industry average, but it might not matter if the company is undervalued. Still, shareholders might want to check if insiders have been selling.

How Does Debt Impact Return On Equity?

Most companies need money -- from somewhere -- to grow their profits. That cash can come from retained earnings, issuing new shares (equity), or debt. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. That will make the ROE look better than if no debt was used.

Akamai Technologies's Debt And Its 13% ROE

Akamai Technologies has a debt to equity ratio of 0.52, which is far from excessive. The combination of modest debt and a very respectable ROE suggests this is a business worth watching. Careful use of debt to boost returns is often very good for shareholders. However, it could reduce the company's ability to take advantage of future opportunities.

The Bottom Line On ROE

Return on equity is useful for comparing the quality of different businesses. In my book the highest quality companies have high return on equity, despite low debt. All else being equal, a higher ROE is better.

Having said that, while ROE is a useful indicator of business quality, you'll have to look at a whole range of factors to determine the right price to buy a stock. It is important to consider other factors, such as future profit growth -- and how much investment is required going forward. So I think it may be worth checking this free report on analyst forecasts for the company.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

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. Thank you for reading.