Is Citi Trends, Inc.’s (NASDAQ:CTRN) High P/E Ratio A Problem For Investors?

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 Citi Trends, Inc.’s (NASDAQ:CTRN), to help you decide if the stock is worth further research. Citi Trends has a price to earnings ratio of 16.80, based on the last twelve months. That means that at current prices, buyers pay $16.80 for every $1 in trailing yearly profits.

Check out our latest analysis for Citi Trends

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Citi Trends:

P/E of 16.80 = USD20.22 ÷ USD1.20 (Based on the year to November 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Citi Trends Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Citi Trends has a higher P/E than the average (14.4) P/E for companies in the specialty retail industry.

NasdaqGS:CTRN Price Estimation Relative to Market, February 28th 2020
NasdaqGS:CTRN Price Estimation Relative to Market, February 28th 2020

Its relatively high P/E ratio indicates that Citi Trends shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

Citi Trends shrunk earnings per share by 17% over the last year. But it has grown its earnings per share by 26% per year over the last five years.

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

The ‘Price’ in P/E reflects the market capitalization of the company. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Citi Trends’s Debt Impact Its P/E Ratio?

Citi Trends has net cash of US$56m. This is fairly high at 23% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Citi Trends’s P/E Ratio

Citi Trends has a P/E of 16.8. That’s around the same as the average in the US market, which is 16.9. While the absence of growth in the last year is probably causing a degree of pessimism, the healthy balance sheet means the company retains potential for future growth. So it’s not surprising to see it trade on a P/E roughly in line with the market.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine. Although we don’t have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

You might be able to find a better buy than Citi Trends. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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. Thank you for reading.