Does Air Canada's (TSE:AC) P/E Ratio Signal A Buying Opportunity?

Simply Wall St

Sat, Jun 1, 2019, 7:19 AM

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Air Canada's (TSE:AC) P/E ratio could help you assess the value on offer. Air Canada has a price to earnings ratio of 15.15, based on the last twelve months. That corresponds to an earnings yield of approximately 6.6%.

See our latest analysis for Air Canada

How Do You Calculate Air Canada's P/E Ratio?

The formula for price to earnings is:

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

Or for Air Canada:

P/E of 15.15 = CA$39.9 ÷ CA$2.63 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Air Canada saw earnings per share decrease by 61% last year. But it has grown its earnings per share by 1.5% per year over the last three years.

Does Air Canada Have A Relatively High Or Low P/E For Its Industry?

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 Air Canada has a P/E ratio that is roughly in line with the airlines industry average (15.8).

TSX:AC Price Estimation Relative to Market, June 1st 2019

Its P/E ratio suggests that Air Canada shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Air Canada actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.