U.S. Markets closed

Why Carolina Financial Corporation's (NASDAQ:CARO) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Carolina Financial Corporation's (NASDAQ:CARO) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Carolina Financial's P/E ratio is 12.93. That means that at current prices, buyers pay $12.93 for every $1 in trailing yearly profits.

View our latest analysis for Carolina Financial

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Carolina Financial:

P/E of 12.93 = $35.23 ÷ $2.72 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. 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.

In the last year, Carolina Financial grew EPS like Taylor Swift grew her fan base back in 2010; the 78% gain was both fast and well deserved. And earnings per share have improved by 22% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.

How Does Carolina Financial's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Carolina Financial has a P/E ratio that is roughly in line with the banks industry average (12.9).

NasdaqCM:CARO Price Estimation Relative to Market, July 2nd 2019

Its P/E ratio suggests that Carolina Financial shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Carolina Financial's Debt Impact Its P/E Ratio?

Carolina Financial has net debt equal to 41% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On Carolina Financial's P/E Ratio

Carolina Financial has a P/E of 12.9. That's below the average in the US market, which is 18.2. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Carolina Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.