Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Delta Air Lines, Inc.'s (NYSE:DAL) P/E ratio to inform your assessment of the investment opportunity. Delta Air Lines has a price to earnings ratio of 7.91, based on the last twelve months. That is equivalent to an earnings yield of about 12.6%.
How Do I Calculate Delta Air Lines's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Delta Air Lines:
P/E of 7.91 = $56.14 ÷ $7.10 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
How Does Delta Air Lines's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (9.0) for companies in the airlines industry is higher than Delta Air Lines's P/E.
Its relatively low P/E ratio indicates that Delta Air Lines shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Delta Air Lines, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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.
Delta Air Lines's earnings made like a rocket, taking off 54% last year. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 4.6%. Regrettably, the longer term performance is poor, with EPS down 9.5% per year over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Delta Air Lines's Balance Sheet
Net debt totals 21% of Delta Air Lines's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Delta Air Lines's P/E Ratio
Delta Air Lines has a P/E of 7.9. That's below the average in the US market, which is 18.5. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Delta Air Lines. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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