This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at America’s Car-Mart, Inc.’s (NASDAQ:CRMT) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, America’s Car-Mart’s P/E ratio is 12.5. That is equivalent to an earnings yield of about 8.0%.
How Do You Calculate A P/E 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?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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.
Does America’s Car-Mart 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 America’s Car-Mart has a lower P/E than the average (13.8) P/E for companies in the specialty retail industry.
Its relatively low P/E ratio indicates that America’s Car-Mart shareholders think it will struggle to do as well as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
America’s Car-Mart increased earnings per share by a whopping 39% last year. And it has bolstered its earnings per share by 24% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
America’s Car-Mart’s Balance Sheet
America’s Car-Mart has net debt equal to 26% of its 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 trades on a P/E ratio of 12.5, which is below the US market average of 17.5. 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.
Investors have an opportunity when market expectations about a stock are wrong. 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.’ So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.