Unfortunately for some shareholders, the Spirit Airlines (NYSE:SAVE) share price has dived 30% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 47% 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 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 Spirit Airlines Have A Relatively High Or Low P/E For Its Industry?
Spirit Airlines’s P/E of 6.07 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (6.7) for companies in the airlines industry is higher than Spirit Airlines’s P/E.
Spirit Airlines’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Spirit Airlines, it’s quite possible it could surprise on the upside. 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
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Spirit Airlines’s earnings made like a rocket, taking off 115% last year. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 9.4%.
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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Spirit Airlines’s P/E?
Net debt totals 53% of Spirit Airlines’s market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Spirit Airlines’s P/E Ratio
Spirit Airlines trades on a P/E ratio of 6.1, which is below the US market average of 16.9. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given Spirit Airlines’s P/E ratio has declined from 8.7 to 6.1 in the last month, we know for sure that the market is more worried about the business today, than it was back then. 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.