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Why Allegiant Travel Company's (NASDAQ:ALGT) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Allegiant Travel Company's (NASDAQ:ALGT) P/E ratio and reflect on what it tells us about the company's share price. What is Allegiant Travel's P/E ratio? Well, based on the last twelve months it is 12.97. That is equivalent to an earnings yield of about 7.7%.

See our latest analysis for Allegiant Travel

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Allegiant Travel:

P/E of 12.97 = $170.05 ÷ $13.11 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does Allegiant Travel's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Allegiant Travel has a higher P/E than the average (9.1) P/E for companies in the airlines industry.

NasdaqGS:ALGT Price Estimation Relative to Market, November 12th 2019

Allegiant Travel'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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Allegiant Travel's earnings per share grew by -3.8% in the last twelve months. And it has bolstered its earnings per share by 19% per year over the last five years. Unfortunately, earnings per share are down 2.5% a year, over 3 years.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. 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).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Allegiant Travel's Balance Sheet Tell Us?

Allegiant Travel has net debt equal to 30% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On Allegiant Travel's P/E Ratio

Allegiant Travel trades on a P/E ratio of 13.0, which is below the US market average of 18.3. The company does have a little debt, and EPS is moving in the right direction. If you believe growth will continue - or even increase - then the low P/E may signify opportunity.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.