The price-to-earnings (P/E) ratio is one of the most widely used valuation measures in the stock market. The ratio is relatively easy to calculate and tells investors what the market is willing to pay for every $1 of a company's earnings. The P/E ratio has also been proved to have a significant relationship with long-term stock returns, so despite its simplicity, it is a great starting point for starting stock analysis. (To learn more, check out our P/E Ratio Tutorial.)
P/Es of comparable companies should generally be the same, unless company-specific factors change the outlook of the company considerably. That means if there are comparable companies, and one is trading at a lower P/E, it may be relatively undervalued. This is a great way to find bargains in the market.
Let's take a look at five stocks with low P/Es worthy of follow-up research. If we research these stocks and buy them when their P/E multiples are below their peers' we have a chance to earn a nice return if the market starts valuing these stocks higher.
|Archer Daniels Midland
|*Data as of market close July 14, 2008.|
Kicking The Tires
Based in Illinois and founded in 1902, Archer Daniels Midland sells ingredients that go into a variety of foods. It provides batter mixes for pancakes and waffles, sweeteners and a variety of other goodies that we often take for granted. ADM has made headlines in recent years for its involvement in and production of ethanol, the increasingly popular corn based fuel. Long story short, if oil prices, and by extension gas prices, continue to rise I'd wager we are going to be hearing a lot more about Archer Daniels in the future. The upcoming election may also help bring the subject of ethanol front and center.
At present, Wall Street analysts are expecting the company to earn $2.93 a share this year and $2.97 a share in 2009. Regardless of your opinion on ethanol as a viable alternative energy source, I think that P/E pretty darn attractive in my book given that the shares trade under $30 a share. (To learn about the problems with ethanol, read The Biofuels Debate Heats Up.)
The New York-based insurer with Snoopy as its mascot has developed a terrific name for itself over the years. Metlife is a huge player here in the States, and it also has a very broad global footprint, with branches in Argentina, Australia, Japan and Mexico. The company is going through a bit of a rough patch right now. In its first quarter, although it generated fees and premiums (and other revenue) of $9.4 billion, its investment portfolio took a hit. The company earned 84 cents per share in the period versus $1.28 per share in the comparable period last year, and its share price has been tumbling as of late.
I wouldn't count out Metlife just yet, however. The currently depressed share price could be a case of undervaluation. At present, the company is expected to earn $6.16 per share in 2008 and $6.85 per share in 2009. In the next five-years, Wall Street analysts expect Metlife to grow at an 11.23% rate per year. That's not too shabby given that the company presently trades in the $50 range.
Buying a stock when its P/E is depressed can provide big payoffs to patient investors. The important thing to do is determine if the characteristics of the company are comparable to its peers and industry. The P/E is often lower because the stock simply does not have the same earnings potential. However, there are many cases where the market sours on a stock in the short term and drives down its P/E. Finding those undervalued gems can help boost portfolio returns.
To learn more on this and other strategies, read our Guide To Stock Picking Strategies.