Between their low in November and last week, the price of shares in Aston Martin (LSE: AML) tripled. That is an incredible performance. Over the longer term though, Aston Martin shares have proven disastrous for many investors. They have lost 94% of their value since listing on the stock exchange less than five years ago.
Could that fall mean today’s price offers me a bargain buying opportunity? Or are the shares already expensive after their recent strong performance?
Using earnings to value shares
One way many investors try to value shares is by using a price-to-earnings (P/E) ratio.
With Aston Martin shares, however, that is tricky. Currently, the company is lossmaking. That means that there are no reported earnings to use as the basis of calculating a P/E ratio.
What about using prospective future earnings instead? The company expects to earn £500m of adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) by 2024/25.
But there are some issues with using this number to value Aston Martin shares, in my view. It is an estimate and may not actually happen.
Earnings per share depend not only on earnings but also on the number of shares in circulation. The carmaker has repeatedly and massively diluted existed shareholders by issuing new equity. It could do so again.
On top of that, I am not comfortable with the adjustments and exclusions. Why exclude interest (as an EBITDA-based approach would) when valuing the company? After all, Aston Martin expects to pay £120m in cash interest costs this year alone. That is substantial.
A final concern I have about using the P/E ratio as a valuation tool in isolation is that a company can have solid earnings (which Aston Martin does not) but high debt (which it does). The £766m of net debt on the firm’s balance sheet will need to be repaid at some point. That will eat into profits and in my view reduces the value of the company overall, even if it starts to generate earnings.
Alternative ways to value Aston Martin shares
But if not a P/E ratio, how can I decide what is a good price for the shares when considering whether to add them to my portfolio?
One approach could be to use a price-to-sales ratio.
But I see that as meaningless. A carmaker like Aston Martin can likely boost sales if it chooses to. Indeed, it is targeting annual wholesale volumes of 10,000 units, a 56% increase on last year. The luxury brand has pricing power that can allow it to boost selling prices without losing sales.
However, in my view, growing sales can decrease not increase the value of a company if it does not also improve profits.
Wait and see
In fact, I do not think there is any way for me to reliably value Aston Martin shares right now.
The company remains heavily loss-making. It has a lot of debt. Sales are growing but whether they can meet management’s aggressive targets remains to be seen.
The company has destroyed vast amounts of shareholder value since listing. I think it is too early to say with confidence that it has now turned the corner and merits even its current valuation, let alone a higher one. So I will not be buying.
The post What’s a good price for Aston Martin shares? appeared first on The Motley Fool UK.
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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.