In This Article:
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Air New Zealand Limited (NZSE:AIR) is trading with a trailing P/E of 9.5x, which is lower than the industry average of 10.2x. While AIR might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Air New Zealand
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for AIR
Price-Earnings Ratio = Price per share ÷ Earnings per share
AIR Price-Earnings Ratio = NZ$3.29 ÷ NZ$0.347 = 9.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AIR, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. AIR’s P/E of 9.5 is lower than its industry peers (10.2), which implies that each dollar of AIR’s earnings is being undervalued by investors. This multiple is a median of profitable companies of stocks internationally, operating in the industry. I’ve decided to use a global peer group as there’s not enough companies in that are considered as appropriate peers, and I wanted to get a broader perspective on the regional multiple. Some peers include , and . You can think of it like this: the market is suggesting that AIR is a weaker business than the average comparable company.
Assumptions to watch out for
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to AIR. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with AIR, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing AIR to are fairly valued by the market. If this does not hold true, AIR’s lower P/E ratio may be because firms in our peer group are overvalued by the market.