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Here's How P/E Ratios Can Help Us Understand Qantas Airways Limited (ASX:QAN)

Simply Wall St

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Qantas Airways Limited's (ASX:QAN) P/E ratio to inform your assessment of the investment opportunity. What is Qantas Airways's P/E ratio? Well, based on the last twelve months it is 10.64. That is equivalent to an earnings yield of about 9.4%.

View our latest analysis for Qantas Airways

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Qantas Airways:

P/E of 10.64 = A$5.55 ÷ A$0.52 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Qantas Airways had pretty flat EPS growth in the last year. But over the longer term (3 years), earnings per share have increased by 1.7%.

Does Qantas Airways Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Qantas Airways has a P/E ratio that is roughly in line with the airlines industry average (11.2).

ASX:QAN Price Estimation Relative to Market, June 1st 2019

That indicates that the market expects Qantas Airways will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Qantas Airways's Balance Sheet Tell Us?

Qantas Airways's net debt equates to 41% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Qantas Airways's P/E Ratio

Qantas Airways has a P/E of 10.6. That's below the average in the AU market, which is 16.1. EPS grew over the last twelve months, and debt levels are quite reasonable. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Qantas Airways. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.