Why WestJet Airlines Ltd.’s (TSE:WJA) High P/E Ratio Isn’t Necessarily A Bad Thing

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how WestJet Airlines Ltd.’s (TSE:WJA) P/E ratio could help you assess the value on offer. WestJet Airlines has a P/E ratio of 20.52, based on the last twelve months. That means that at current prices, buyers pay CA$20.52 for every CA$1 in trailing yearly profits.

Check out our latest analysis for WestJet Airlines

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for WestJet Airlines:

P/E of 20.52 = CA$18.52 ÷ CA$0.90 (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 CA$1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

WestJet Airlines saw earnings per share decrease by 61% last year. And EPS is down 15% a year, over the last 5 years. This might lead to muted expectations.

How Does WestJet Airlines’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that WestJet Airlines has a higher P/E than the average (18.4) P/E for companies in the airlines industry.

TSX:WJA Price Estimation Relative to Market, May 13th 2019
TSX:WJA Price Estimation Relative to Market, May 13th 2019

That means that the market expects WestJet Airlines will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 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.

So What Does WestJet Airlines’s Balance Sheet Tell Us?

WestJet Airlines has net debt worth 61% of its market capitalization. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On WestJet Airlines’s P/E Ratio

WestJet Airlines has a P/E of 20.5. That’s higher than the average in the CA market, which is 14.6. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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.

But note: WestJet Airlines may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.