What Does Southwest Airlines Co.'s (NYSE:LUV) P/E Ratio Tell You?

Simply Wall St

Sun, May 5, 2019, 7:57 AM

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Southwest Airlines Co.'s (NYSE:LUV) P/E ratio and reflect on what it tells us about the company's share price. Southwest Airlines has a price to earnings ratio of 12.6, based on the last twelve months. That is equivalent to an earnings yield of about 7.9%.

View our latest analysis for Southwest Airlines

How Do I Calculate Southwest Airlines's Price To Earnings Ratio?

The formula for P/E is:

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

Or for Southwest Airlines:

P/E of 12.6 = $53.37 ÷ $4.24 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Southwest Airlines saw earnings per share decrease by 28% last year. But over the longer term (5 years) earnings per share have increased by 29%.

Does Southwest Airlines Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (11.6) for companies in the airlines industry is lower than Southwest Airlines's P/E.

NYSE:LUV Price Estimation Relative to Market, May 5th 2019

That means that the market expects Southwest Airlines will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and 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. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.