Regardless of climbing 105% in 5 years, Worldwide Consolidated Airways Group (LSE:IAG) shares commerce at a price-to-earnings (P/E) a number of of 9. That’s nicely beneath the FTSE 100 common of 17. 

It’s additionally nicely beneath the a number of the inventory traded at a yr in the past, which was 21. So is that this an enormous alternative, or is one thing else occurring?

Operational leverage

Practically each enterprise goes by way of ups and downs, however some extra so than others. And airways are among the most unstable in the case of earnings. The largest prices are gas, workers, airport charges, and plane. And importantly, these are the identical whether or not a aircraft is 99% full or 60% empty. 

That may be nice when issues are going nicely. With the ability to add extra clients with virtually no additional price means virtually all of the income from ticket gross sales converts to income. Equally although, earnings can evaporate shortly when demand drops and airways finish up flying fewer passengers at no actual discount in prices. And IAG’s P/E a number of is a mirrored image of this.

Usually, the P/E ratio a inventory trades at doesn’t truly inform buyers a lot about how low-cost it’s. What it does say, is what the market’s anticipating from the underlying enterprise.

When a inventory trades at a excessive a number of, it’s an indication buyers are anticipating progress. Equally, a low P/E ratio is an effective indication that buyers assume there could be troublesome occasions forward.

Turbulence forward?

IAG shares buying and selling at a P/E ratio of 9 means buyers assume this are about as seemingly as they’re going to get, no less than for now. However it’s price noting analysts don’t appear to agree. 

Earnings per share are forecast to extend from 46p in 2024 to 71p over the following three years. If that occurs, the inventory’s buying and selling at a P/E a number of of round 4 primarily based on 2028 earnings. 

Personally although, I’m on the aspect of the market. I believe there are a few the reason why investing primarily based on an expectation of regular revenue progress over the following few years is sort of dangerous.

One is the opportunity of a recession. The UK is IAG’s largest market and I believe the prospect of Britain getting into an financial downturn within the close to future is unusually excessive proper now. One other is the danger of one-off occasions, such because the current fireplace at Heathrow. The monetary affect on IAG’s unclear, but it surely jogs my memory of the IT outage in 2017 that price the agency £80m.

To some extent, all companies face exogenous threats. However the danger is bigger for firms with excessive fastened prices – corresponding to IAG – the place the affect on income is extra profound.

April alternative?

Different issues being equal, it’s higher to purchase shares at a decrease earnings a number of than the next one. However with cyclical companies like IAG, different issues aren’t equal.

Heading into April, quite a bit has been going proper for IAG. However that is when the dangers are best and buyers should be most cautious. I believe that’s what a low P/E a number of is – rightly – reflecting.

There are just a few FTSE 100 shares I’m seeking to purchase this month, however IAG isn’t certainly one of them.