To the annoyance of some shareholders, Deutsche Lufthansa (ETR:LHA) shares are down a considerable 42% in the last month. That drop has capped off a tough year for shareholders, with the share price down 59% in that time.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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 ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Deutsche Lufthansa Have A Relatively High Or Low P/E For Its Industry?
Deutsche Lufthansa’s P/E of 3.01 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 (6.9) in the airlines industry classification.
This suggests that market participants think Deutsche Lufthansa will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
If earnings fall then in the future the ‘E’ will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Deutsche Lufthansa shrunk earnings per share by 40% over the last year. But it has grown its earnings per share by 20% per year over the last five years. And it has shrunk its earnings per share by 9.1% per year over the last three years. This could justify a low P/E.
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. So it won’t reflect the advantage of cash, or disadvantage of debt. 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.
How Does Deutsche Lufthansa’s Debt Impact Its P/E Ratio?
Deutsche Lufthansa’s net debt is 66% of its market cap. 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 Deutsche Lufthansa’s P/E Ratio
Deutsche Lufthansa trades on a P/E ratio of 3.0, which is below the DE market average of 16.8. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. 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 5.2 back then to 3.0 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.
Of course you might be able to find a better stock than Deutsche Lufthansa. 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.
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. Thank you for reading.
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