Is American Electric Power Company, Inc.’s (NASDAQ:AEP) ROE of 9.9% impressive?

While some investors are already well-versed in financial metrics (hat tip), this article is for those who want to learn about Return On Equity (ROE) and why it’s important. Learning by doing, we will look at ROE to better understand American Electric Power Company, Inc. (NASDAQ:AEP).

ROE or return on equity is a useful tool for assessing how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company’s success in turning shareholder investment into profits.

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) ÷ Equity

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

9.9% = 2.6 billion USD ÷ 27 billion USD (Based on last 12 months to September 2024).

The ‘return’ is the annual profit. This means that for every $1 worth of equity, the company generated $0.10 in profit.

Does American Electric Power Company have a good return on equity?

A 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 the companies differ quite a bit within the same industry classification. If you look at the image below, you can see that American Electric Power Company has a similar ROE to the average in the Electric Utilities industry classification (9.3%).

It’s not great, but it’s respectable. Although the ROE is respectable compared to the industry, it is worth checking whether the company’s ROE is being helped by high debt levels. If so, this increases its exposure to financial risks. To know the 2 risks we have identified for American Electric Power Company, visit our risk dashboard for free.

Why you should consider debt when looking at ROE

Businesses usually need to invest money to increase their profits. This cash can come from retained earnings, issuing new shares (equity) or debt. In the first and second cases, ROE will reflect this use of cash for investment in the business. In the latter case, the debt used for growth will improve returns but will not affect total equity. It will make ROE look better than if no debt was used.

Combines American Electric Power Company’s debt and its 9.9% return on equity

American Electric Power Company is clearly using a high amount of debt to increase returns as it has a debt to equity ratio of 1.64. The combination of a fairly low ROE and significant use of debt is not very appealing. Debt carries extra risk, so it’s only really worthwhile when a business generates a decent return from it.

Conclusion

Return on equity is a useful indicator of a company’s ability to generate profits and return them to shareholders. Companies that can achieve high returns on equity without too much debt are generally of good quality. All other things being equal, a higher ROE is better.

But ROE is only one piece of a larger puzzle, as high-quality companies often trade at high multiples of earnings. Profit growth rates versus the expectations reflected in the share price is a particularly important consideration. So you might want to check out this FREE visualization of analyst forecasts for the company.

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

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This article by Simply Wall St is general. We only provide commentary based on historical data and analyst forecasts 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 shares and does not take into account your goals or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not take into account recent price-sensitive company announcements or qualitative material. Simply Wall St has no position in any listed stocks.