Yahoo Finance Should You Be Tempted To Sell Akamai Technologies Inc (NASDAQ:AKAM) Because Of Its PE Ratio?
This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Akamai Technologies Inc (NASDAQ:AKAM) is trading with a trailing P/E of 61.4, which is higher than the industry average of 26.7. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Akamai Technologies
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for AKAM
Price-Earnings Ratio = Price per share ÷ Earnings per share
AKAM Price-Earnings Ratio = $66.32 ÷ $1.08 = 61.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AKAM, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since AKAM’s P/E of 61.4 is higher than its industry peers (26.7), it means that investors are paying more for each dollar of AKAM’s earnings. This multiple is a median of profitable companies of 25 IT companies in US including e-Synergies, Steel Connect and Value Exchange International. You could also say that the market is suggesting that AKAM is a stronger business than the average comparable company.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to AKAM. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Akamai Technologies Inc is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to AKAM may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
Since you may have already conducted your due diligence on AKAM, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for AKAM’s future growth? Take a look at our free research report of analyst consensus for AKAM’s outlook.
Past Track Record: Has AKAM been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of AKAM’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
