International Consolidated Airlines Group SA (LSE:IAG) is currently trading at a trailing P/E of 7.8x, which is lower than the industry average of 8.6x. While this makes IAG appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for International Consolidated Airlines Group
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 pound of the company’s earnings.
P/E Calculation for IAG
Price-Earnings Ratio = Price per share ÷ Earnings per share
IAG Price-Earnings Ratio = €7.15 ÷ €0.919 = 7.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to IAG, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. IAG’s P/E of 7.8x is lower than its industry peers (8.6x), which implies that each dollar of IAG’s earnings is being undervalued by investors. Therefore, according to this analysis, IAG is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that IAG is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to IAG, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with IAG, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing IAG to are fairly valued by the market. If this does not hold true, IAG’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
To help readers see pass 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.