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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Culp, Inc.'s (NYSE:CULP) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Culp has a P/E ratio of 33.89. That corresponds to an earnings yield of approximately 3.0%.
See our latest analysis for Culp
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Culp:
P/E of 33.89 = $16.51 ÷ $0.49 (Based on the year to August 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
Does Culp 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. As you can see below, Culp has a higher P/E than the average company (17.6) in the luxury industry.
Its relatively high P/E ratio indicates that Culp shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Culp saw earnings per share decrease by 64% last year. And EPS is down 19% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
So What Does Culp's Balance Sheet Tell Us?
Culp has net cash of US$43m. This is fairly high at 21% 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.