This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Air Lease Corporation (NYSE:AL)’s fundamentals and stock market performance.
Air Lease Corporation (NYSE:AL) is currently trading at a trailing P/E of 5.6x, which is lower than the industry average of 14.5x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Air Lease
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for AL
Price-Earnings Ratio = Price per share ÷ Earnings per share
AL Price-Earnings Ratio = $42.57 ÷ $7.562 = 5.6x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AL, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. AL’s P/E of 5.6x is lower than its industry peers (14.5x), which implies that each dollar of AL’s earnings is being undervalued by investors. As such, our analysis shows that AL represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy AL, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to AL, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with AL, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing AL to are fairly valued by the market. If this is violated, AL’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of AL to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 AL’s future growth? Take a look at our free research report of analyst consensus for AL’s outlook.
- Past Track Record: Has AL 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 AL’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 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.