Is Allegiant Travel Company's (NASDAQ:ALGT) High P/E Ratio A Problem For Investors?

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Allegiant Travel Company’s (NASDAQ:ALGT), to help you decide if the stock is worth further research. What is Allegiant Travel’s P/E ratio? Well, based on the last twelve months it is 13.85. That corresponds to an earnings yield of approximately 7.2%.

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Check out our latest analysis for Allegiant Travel

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 Allegiant Travel:

P/E of 13.85 = $140.16 ÷ $10.12 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

Allegiant Travel shrunk earnings per share by 22% over the last year. But over the longer term (5 years) earnings per share have increased by 15%. And over the longer term (3 years) earnings per share have decreased 9.1% annually. This could justify a low P/E.

Does Allegiant Travel Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (10.9) for companies in the airlines industry is lower than Allegiant Travel’s P/E.

NasdaqGS:ALGT Price Estimation Relative to Market, May 15th 2019

Its relatively high P/E ratio indicates that Allegiant Travel shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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 Allegiant Travel’s Balance Sheet Tell Us?

Net debt is 37% of Allegiant Travel’s market cap. While it’s worth keeping this in mind, it isn’t a worry.

The Verdict On Allegiant Travel’s P/E Ratio

Allegiant Travel trades on a P/E ratio of 13.9, which is below the US market average of 17.8. With only modest debt, it’s likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.