This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Aircastle Limited’s (NYSE:AYR) P/E ratio to inform your assessment of the investment opportunity. Aircastle has a P/E ratio of 6.47, based on the last twelve months. In other words, at today’s prices, investors are paying $6.47 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Aircastle:
P/E of 6.47 = $20.59 ÷ $3.18 (Based on the trailing twelve months to December 2018.)
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. 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Aircastle increased earnings per share by a whopping 69% last year. And earnings per share have improved by 27% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Aircastle’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (13.9) for companies in the trade distributors industry is higher than Aircastle’s P/E.
This suggests that market participants think Aircastle will underperform other companies in its industry. Since the market seems unimpressed with Aircastle, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Aircastle’s Balance Sheet
Net debt totals a substantial 298% of Aircastle’s market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On Aircastle’s P/E Ratio
Aircastle trades on a P/E ratio of 6.5, which is below the US market average of 17.8. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Aircastle 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).
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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. Thank you for reading.