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A popular way many investors assess a company’s value is through the price-to-earnings (P/E) ratio. I use a benchmark figure of 10 for the ratio fair value, but I can also look at the index average to compare it against. A low figure can indicate a stock is undervalued and here’s a FTSE 100 share with a significantly lower value than its peers!
Cheap versus potential
I’m referring to easyJet (LSE:EZJ). The airline operator currently has a P/E ratio of 7.37, well below the FTSE 100 average of 18.2. Over the past year, the stock’s down 15%.
There are a few reasons why I think the stock looks undervalued right now. Last month, it reported a pre-tax profit of £665m for the year to September. As part of that, its package holidays arm proved to be a decent contributor to growth. It’s just one of the ways the business is diversifying revenue beyond just flights.
As a result, I don’t think investors are fully appreciating the value going forward, as it’s reshaping its business into something more resilient than just being a pure airline.
Additionally, easyJet’s been transitioning its fleet to more efficient aircraft, which consume less fuel and lower unit costs, especially as older planes are phased out. So going forward, operational efficiency should be higher, given the improved aircraft and crew productivity on the new planes. This should filter through to the bottom line, helping company profitability. So when I look at the stock’s current value versus its potential based on future earnings, it does look undervalued.
Risks to note
Before everyone rushes to buy the stock, there are some risks worth flagging. I read a note from the team at JP Morgan last week, where they downgraded their view of the company. The team cited concerns over pricing pressure from rising capacity, weaker fares in Europe, and cost pressures that may erode margins.
They’re valid factors which could scare some people away. Let’s also not forget what happened during the pandemic. Some investors have very bad memories of the stock market’s performance during the lockdown plunge. It might be the case that some don’t feel comfortable going near the stock again.
Even with these concerns, I think easyJet is undervalued right now, given the strategy it’s pursuing. Yet I struggle to see it remaining so cheap relative to the broader index. It’s part of the normal market cycle that, over time, investors tend to ignore expensive stocks and purchase cheaper options. So over the coming years, this should act to naturally boost the easyJet share price and bring it back more in line with the market P/E average.
Overall, I think it’s a stock worth considering for investors looking for an undervalued pick.
