The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want a simplistic look at the return on Axon Enterprise Inc (NASDAQ:AAXN) stock.
Axon Enterprise Inc (NASDAQ:AAXN) generated a below-average return on equity of 6.80% in the past 12 months, while its industry returned 13.69%. AAXN’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on AAXN’s performance. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of AAXN’s returns. Check out our latest analysis for Axon Enterprise
Peeling the layers of ROE – trisecting a company’s profitability
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.068 in earnings from this. Investors seeking to maximise their return in the Aerospace and Defense industry may want to choose the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Axon Enterprise’s equity capital deployed. Its cost of equity is 9.06%. Since Axon Enterprise’s return does not cover its cost, with a difference of -2.26%, this means its current use of equity is not efficient and not sustainable. Very simply, Axon Enterprise pays more for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Axon Enterprise can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. We can assess whether Axon Enterprise is fuelling ROE by excessively raising debt. Ideally, Axon Enterprise should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently, Axon Enterprise has no debt which means its returns are driven purely by equity capital. This could explain why Axon Enterprise’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Axon Enterprise’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Axon Enterprise’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Axon Enterprise, there are three pertinent factors you should further research:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Valuation: What is Axon Enterprise worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Axon Enterprise is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Axon Enterprise? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!