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Shares in International Consolidated Airlines Group (LSE:IAG) have climbed almost 100% over the last 12 months. But that doesn’t automatically mean the stock’s expensive or overvalued.
Whether or not a stock’s a bargain depends on how much cash the company makes – and IAG shares look cheap at a price-to-earnings (P/E) ratio of 7. But I’m not so sure this is the case.
P/E multiples
A low P/E multiple can be an encouraging sign, especially for investors focused on value. It suggests a company doesn’t have to grow much for its cash flows to generate a good return for shareholders.
By itself though, the P/E ratio a stock trades at doesn’t reflect anything about its valuation. What it does show is what investors are expecting from the company going forward.
Stocks are undervalued when the market’s expectations for the underlying business are below what it can achieve going forward. And this can be the case whether the expectations are low or high.
Other things being equal, it’s obviously easier to outperform low expectations than high ones. But not all companies are equal and this is something investors need to account for.
Passenger numbers
Given this, it’s fair to say expectations for IAG shares are low right now. A P/E ratio of 7 is below the FTSE 100 average and relatively low compared to where the stock has traded at for the last five years.
In other words, investors don’t think the company can grow its earnings much from their current levels. And one reason for this might be the number of passengers it carried in 2024.
| Year | IAG Passenger Numbers |
|---|---|
| 2024 | 122m |
| 2023 | 115.6m |
| 2022 | 94.7m |
| 2021 | 38.9m |
| 2020 | 31.3m |
| 2019 | 118m |
| 2018 | 112m |
| 2017 | 104m |
| 2016 | 100m |
| 2015 | 88.3m |
Over the last few years, demand for air travel’s been recovering from Covid-19 lows. But it’s now reached record highs, so I think it might well be much harder for this to keep increasing.
While passenger numbers have increased over the long term, this hasn’t been a linear process. And when numbers are at their highest, the risk of this falling away’s greater.
Operational leverage
IAG has a lot of operational leverage. In other words, when passenger numbers increase, revenues go up but its costs are largely the same.
This is great when things go well – sales growth leads to widening margins, causing profits to rise more quickly than revenues. This is what’s been happening over the last few years.
Unfortunately, the reverse is true when things turn around. A downturn in sales doesn’t necessarily bring lower costs and earnings fall away sharply.
I think that means investors are right to be wary of IAG shares at the moment. Passenger numbers are at unusually high levels and a slight downturn could have significant effect on profits.
A no-brainer buy?
Record passenger numbers have propelled IAG shares higher recently. And there’s more that could go right from here – lower oil prices leading to reduced fuel costs being one example.
In my view though, there’s also a lot that can go wrong. So despite the low P/E ratio, I think the stock’s a long way from being a no-brainer buy to consider.
