One common valuation metric for shares is the price-to-earnings (P/E) ratio. Rule of thumb is that the lower it is, the cheaper a share is. To illustrate, consider British Airways’ parent International Consolidated Airlines Group (LSE: IAG). The IAG P/E ratio at the moment is just six.
So could now be the moment for me to scoop up this apparent value share?
Difficult business sector for investors
My answer is no. Before I get into the specifics of the current IAG share price, I ought to mention that I have owned the share in the past and one of my lessons was how difficult it can be for an investor to make smart investing choices when it comes to airlines.
A company can have a strong brand, lots of customers, be well-run – and still lose money hand over fist. External factors from the oil price to volcanic clouds and pandemics can all suddenly overwhelm the economics of the business.
Clearly, some investors can make money. Over the past five years, for example, the IAG share price has risen 81%.
But patience and strong nerves help when it comes to strapping your money to the wings of a plane, in my view.
Potential bargain, potential value trap
What then about the specifics of the IAG investment case right now? The business has had a solid few years. It is very profitable and pays a dividend to shareholders.
But the P/E ratio refers to most recently reported earnings and here is where I have a concern. Can IAG maintain its earnings at their current level?
Global economic uncertainty threatens passenger demand for flights across the board. When the economy gets tough, business flyers usually travel less – and that lucrative market has not even recovered to pre-pandemic levels on many routes.
Meanwhile, a weak economy can also mean leisure travellers spend less on holidays, or simply stay at home.
IAG airlines BA, Iberia and Aer Lingus are all heavily dependent on transatlantic routes. BA expects to set a new record for its number of North American destinations this summer, with 26 US cities set to be served.
With inbound tourism to the US falling and trade disputes threatening business links between the US and Europe, I see a risk that IAG’s transatlantic passenger numbers could fall sharply, hurting profits.
Suddenly, a P/E ratio that looks like a potential brilliant bargain may look different. The current IAG share price could turn out to be a value trap, if the company’s earnings decline badly.
Clearer value elsewhere
In February when it announced its annual results, IAG was confident about the outlook and said it was “expecting to deliver sustainable earnings per share growth”. It has not amended that guidance since and, if the firm delivers, today’s IAG share price could indeed turn out to be a bargain.
My concern is that the trade disputes alone pose a real risk to IAG, let alone self-inflicted wounds like its badly received revamp of BA’s loyalty scheme.
In a market where I think there are some great value shares on offer right now, I do not like the IAG risk profile and will not be buying the share.
