This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to America's Car-Mart, Inc.'s (NASDAQ:CRMT), to help you decide if the stock is worth further research. America's Car-Mart has a P/E ratio of 12.5, based on the last twelve months. That means that at current prices, buyers pay $12.5 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for America's Car-Mart:
P/E of 12.5 = $87.35 ÷ $6.99 (Based on the year to April 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does America's Car-Mart Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that America's Car-Mart has a lower P/E than the average (13.8) P/E for companies in the specialty retail industry.
America's Car-Mart's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with America's Car-Mart, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's nice to see that America's Car-Mart grew EPS by a stonking 39% in the last year. And its annual EPS growth rate over 5 years is 24%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting America's Car-Mart's P/E?
Net debt is 26% of America's Car-Mart's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On America's Car-Mart's P/E Ratio
America's Car-Mart's P/E is 12.5 which is below average (17.5) in the US market. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than America's Car-Mart. So you may wish to see this free collection of other companies that have grown earnings strongly.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.