Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Auckland International Airport Limited's (NZSE:AIA) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Auckland International Airport's P/E ratio is 20.16. That means that at current prices, buyers pay NZ$20.16 for every NZ$1 in trailing yearly profits.
How Do You Calculate Auckland International Airport's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Auckland International Airport:
P/E of 20.16 = NZ$8.75 ÷ NZ$0.43 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Auckland International Airport Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Auckland International Airport has a lower P/E than the average (29.9) in the infrastructure industry classification.
Auckland International Airport's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Auckland International Airport shrunk earnings per share by 20% over the last year. But over the longer term (5 years) earnings per share have increased by 21%.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Auckland International Airport's Debt Impact Its P/E Ratio?
Net debt totals 21% of Auckland International Airport's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Auckland International Airport's P/E Ratio
Auckland International Airport trades on a P/E ratio of 20.2, which is fairly close to the NZ market average of 19.5. Given it has some debt, but didn't grow last year, the P/E indicates the market is expecting higher profits ahead for the business.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you spot an error that warrants correction, please contact the editor at email@example.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.