Despite Its High P/E Ratio, Is Gama Aviation Plc (LON:GMAA) Still Undervalued?
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Gama Aviation Plc’s (LON:GMAA) P/E ratio and reflect on what it tells us about the company’s share price. Gama Aviation has a price to earnings ratio of 9.46, based on the last twelve months. In other words, at today’s prices, investors are paying £9.46 for every £1 in prior year profit.
View our latest analysis for Gama Aviation
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Gama Aviation:
P/E of 9.46 = $1.51 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.16 (Based on the year to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each £1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Gama Aviation’s earnings per share fell by 64% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 55%.
How Does Gama Aviation’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (9) for companies in the airlines industry is roughly the same as Gama Aviation’s P/E.
Gama Aviation’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if Gama Aviation actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Gama Aviation’s P/E?
The extra options and safety that comes with Gama Aviation’s US$21m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Gama Aviation’s P/E Ratio
Gama Aviation trades on a P/E ratio of 9.5, which is below the GB market average of 15.1. The recent drop in earnings per share would make investors cautious, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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.
You might be able to find a better buy than Gama Aviation. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
