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Should You Be Tempted To Sell American Airlines Group Inc. (NASDAQ:AAL) Because Of Its P/E Ratio?

Jacob Boyd

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use American Airlines Group Inc.’s (NASDAQ:AAL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, American Airlines Group’s P/E ratio is 13.44. That means that at current prices, buyers pay $13.44 for every $1 in trailing yearly profits.

Check out our latest analysis for American Airlines Group

How Do I Calculate American Airlines Group’s Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for American Airlines Group:

P/E of 13.44 = $32.95 ÷ $2.45 (Based on the year to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

American Airlines Group shrunk earnings per share by 43% over the last year. But it has grown its earnings per share by 14% per year over the last five years. And EPS is down 46% a year, over the last 3 years. This might lead to low expectations.

How Does American Airlines Group’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that American Airlines Group has a higher P/E than the average (8.8) P/E for companies in the airlines industry.

NasdaqGS:AAL PE PEG Gauge January 8th 19

American Airlines Group’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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.

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.

Is Debt Impacting American Airlines Group’s P/E?

American Airlines Group has net debt worth a very significant 135% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Bottom Line On American Airlines Group’s P/E Ratio

American Airlines Group has a P/E of 13.4. That’s below the average in the US market, which is 16.5. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations.

Investors have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: American Airlines Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.