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Financial Theory
P/E increases as earnings grow
P/E decreases as cost of equity increases
ROE is based on Dupont (Earnings/Equity)
If ROE<Cost of Equity, P/B decreases
Delta Airlines
1.Long haul carrier
Delta Airlines
carrier
Southwest Airlines
1. Hybrid carrier
2. Founded in 1971, now operates 344 aircrafts to 57
destinations
3. Focus is on frequent flights to conveniently located and
less congested airports
4. Waiting time is low & operates only 1 type of aircraft
Airline Industry
Price-to-book value
2
P/B trend
declining
Price/Earning
Negative
P/E trend
decling
ROE
12%
ROE trend
declining
Cost of equity capital
12.50%
Revenue growth
Earnings Growth
Predicted ROE
2001
NA
Loss
NA
Delta
Price-to-book value
P/B trend
Price/Earning
P/E trend
ROE
ROE trend
Cost of equity capital
Net Operating Margin
Net Operating Margin trend
American
2002
8%
Profit
8.50%
a
NA
NA
NA
NA
17%
declining
12.50%
6%
declining
American
Price-to-book value
P/B trend
Price/Earning
P/E trend
ROE
ROE trend
Cost of equity capital
Net Operating Margin
Net Operating Margin trend
NA
NA
NA
NA
12%
declining
12.50%
5%
declining
Delta
2001
NA
Loss
NA
2002
NA
Moderate Increase
13%
2002
>30%
32%
23%
Skywest
Price-to-book value
P/B trend
Price/Earning
P/E trend
ROE
ROE trend
Cost of equity capital
Net Operating Margin
Net Operating Margin trend
Skywest
2003
>30%
22%
23%
est
NA
NA
NA
NA
18%
declining
12.50%
9%
declining
2001
11%
19%
17%
Southwest
Price-to-book value
P/B trend
Price/Earning
P/E trend
ROE
ROE trend
Cost of equity capital
Net Operating Margin
Net Operating Margin trend
Southwest
2002
12%
24%
18%
NA
NA
NA
NA
21%
increasing
12.50%
11%
increasing
ROE
P/E
P/B
American
Low
Low
Low
ROE<CEC, P/B<1
7.5
6.8
16.8
26.8
Delta
Average
Low
Low-to-average
P/B~1
0.8
1.2
3.1
4.9
Southwest
High
High
High
Sustained Growth
American
Delta
Skywest
Southwest
Skywest
High
High
High
P/B>>1
igh competition for routes, low historical ROE, low PE as earnings growth not over CEC, PB <1 since ROE < CEC
igh competition for routes, average historical ROE, ROE > CEC, so PB >1, low PE
lexible, non-union labour, low cost strategy sustainable, high PB, high PE due to presumably sustainable long-te
erves larger air carriers who can also compete directly, depends on Delta/United for business ~ maybe earnings
Trend
Rising
P/E
P/B
ROE
High
High
High
High
Low
Low
Low
High
High
Low
Low
Low
Recovering
Falling
Takeover/Bankruptcy
Interpretation
Expectations of high earnings growth relative to recent earnings(high P/E)
Earnings growth will increase the asset base (high P/B)
Both will contribute to rising ROE
The firm will recover from recently lower earnings (high P/E)
Will not exibit growth in asset base (low P/B)
Will not show high returns (low ROE)
The firm will not grow earnings beyond current levels (low P/E)
High earnings expected on current investments (high P/B and high ROE)
New investments returns will be low
The firm will experience earnings growth (high P/E)
Will not exibit growth in asset base (low P/B)
Below average returns are expected (low ROE)