Advertisement
Canada markets closed

  • S&P/TSX

    24,439.08
    -32.09 (-0.13%)
     

  • S&P 500

    5,815.26
    -44.59 (-0.76%)
     

  • DOW

    42,740.42
    -324.80 (-0.75%)
     

  • CAD/USD

    0.7261
    +0.0012 (+0.17%)
     

  • CRUDE OIL

    71.04
    -2.79 (-3.78%)
     

  • Bitcoin CAD

    91,354.19
    +750.63 (+0.83%)
     

  • XRP CAD

    0.74
    -0.01 (-0.85%)
     

  • GOLD FUTURES

    2,679.40
    +13.80 (+0.52%)
     

  • RUSSELL 2000

    2,249.82
    +1.18 (+0.05%)
     

  • 10-Yr Bond

    4.0380
    -0.0600 (-1.46%)
     

  • NASDAQ futures

    20,333.25
    -286.00 (-1.39%)
     

  • VOLATILITY

    20.64
    +0.94 (+4.77%)
     

  • FTSE

    8,249.28
    -43.38 (-0.52%)
     

  • NIKKEI 225

    39,910.55
    +304.75 (+0.77%)
     

  • CAD/EUR

    0.6662
    +0.0020 (+0.30%)
     

Does American Electric Power Company, Inc. (NASDAQ:AEP) Create Value For Shareholders?

editorial-team@simplywallst.com (Simply Wall St)
·3 min read

One of the best investments we can make is in our own knowledge and skill set. With that in mind, this article will work through how we can use Return On Equity (ROE) to better understand a business. We'll use ROE to examine American Electric Power Company, Inc. (NASDAQ:AEP), by way of a worked example.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for American Electric Power Company

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for American Electric Power Company is:

10% = US$2.6b ÷ US$26b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 in profit.

Does American Electric Power Company Have A Good ROE?

One simple way to determine if a company has a good return on equity is to compare it to the average for its industry. Importantly, this is far from a perfect measure, because companies differ significantly within the same industry classification. If you look at the image below, you can see American Electric Power Company has a similar ROE to the average in the Electric Utilities industry classification (9.2%).

roe
roe

That's neither particularly good, nor bad. While at least the ROE is not lower than the industry, its still worth checking what role the company's debt plays as high debt levels relative to equity may also make the ROE appear high. If true, then it is more an indication of risk than the potential. You can see the 3 risks we have identified for American Electric Power Company by visiting our risks dashboard for free on our platform here.

How Does Debt Impact ROE?

Virtually all companies need money to invest in the business, to grow profits. That cash can come from issuing shares, retained earnings, or debt. In the first and second cases, the ROE will reflect this use of cash for investment in the business. In the latter case, the use of debt will improve the returns, but will not change the equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

American Electric Power Company's Debt And Its 10% ROE

American Electric Power Company does use a high amount of debt to increase returns. It has a debt to equity ratio of 1.67. With a fairly low ROE, and significant use of debt, it's hard to get excited about this business at the moment. Investors should think carefully about how a company might perform if it was unable to borrow so easily, because credit markets do change over time.

Conclusion

Return on equity is useful for comparing the quality of different businesses. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have the same ROE, then I would generally prefer the one with less debt.

But when a business is high quality, the market often bids it up to a price that reflects this. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So I think it may be worth checking this free report on analyst forecasts for the company.

Of course American Electric Power Company may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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.