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Should We Worry About Alliance Aviation Services Limited's (ASX:AQZ) P/E Ratio?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Alliance Aviation Services Limited's (ASX:AQZ) P/E ratio and reflect on what it tells us about the company's share price. What is Alliance Aviation Services's P/E ratio? Well, based on the last twelve months it is 13.43. That is equivalent to an earnings yield of about 7.4%.

Check out our latest analysis for Alliance Aviation Services

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Alliance Aviation Services:

P/E of 13.43 = A$2.45 ÷ A$0.18 (Based on the year to June 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 Alliance Aviation Services's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below Alliance Aviation Services has a P/E ratio that is fairly close for the average for the airlines industry, which is 12.7.

ASX:AQZ Price Estimation Relative to Market, December 23rd 2019
ASX:AQZ Price Estimation Relative to Market, December 23rd 2019

Its P/E ratio suggests that Alliance Aviation Services shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

It's great to see that Alliance Aviation Services grew EPS by 24% in the last year. And its annual EPS growth rate over 5 years is 13%. This could arguably justify a relatively high P/E ratio.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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

Alliance Aviation Services's Balance Sheet

Alliance Aviation Services has net debt worth 16% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Bottom Line On Alliance Aviation Services's P/E Ratio

Alliance Aviation Services has a P/E of 13.4. That's below the average in the AU market, which is 18.8. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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.

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.

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. Thank you for reading.