To the annoyance of some shareholders, Deutsche Lufthansa (ETR:LHA) shares are down a considerable 31% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 54% drop over twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Deutsche Lufthansa Have A Relatively High Or Low P/E For Its Industry?
Deutsche Lufthansa’s P/E of 3.55 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Deutsche Lufthansa has a lower P/E than the average (5.6) in the airlines industry classification.
This suggests that market participants think Deutsche Lufthansa will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
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. Then, a higher P/E might scare off shareholders, pushing the share price down.
Deutsche Lufthansa’s earnings per share fell by 44% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 85%. And EPS is down 13% a year, over the last 3 years. This growth rate might warrant a low P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Deutsche Lufthansa’s Balance Sheet
Deutsche Lufthansa has net debt worth 88% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Bottom Line On Deutsche Lufthansa’s P/E Ratio
Deutsche Lufthansa trades on a P/E ratio of 3.5, which is below the DE market average of 16.5. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations. What can be absolutely certain is that the market has become more pessimistic about Deutsche Lufthansa over the last month, with the P/E ratio falling from 5.1 back then to 3.5 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
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 Deutsche Lufthansa. 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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