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Flight Centre Travel Group Limited (ASX:FLT) trades with a trailing P/E of 24.9x, which is lower than the industry average of 26x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, 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 Flight Centre Travel Group
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for FLT
Price-Earnings Ratio = Price per share ÷ Earnings per share
FLT Price-Earnings Ratio = A$63.63 ÷ A$2.56 = 24.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to FLT, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. FLT’s P/E of 24.9x is lower than its industry peers (26x), which implies that each dollar of FLT’s earnings is being undervalued by investors. Therefore, according to this analysis, FLT is an under-priced stock.
A few caveats
However, before you rush out to buy FLT, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to FLT, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FLT, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing FLT to are fairly valued by the market. If this does not hold, there is a possibility that FLT’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on FLT, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: