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:
|Company||Trailing P/E||Market Cap|
|Chubb Corp. (NYSE:CB)||7.25||16.8B|
|Goldman Sachs (NYSE:GS)||8.25||68.2B|
|Royal Caribbean Cruises (NYSE:RCL)||8.34||5.2B|
|Data as of market close July 28, 2008|
Royal Caribbean Ready To Cruise?
I think that Royal Caribbean deserves a closer look for several reasons. First off, I think the company, and cruises in general, will become more popular in the coming year. Airfare is becoming increasingly expensive thanks to fuel costs. Cruising could become a more popular vacation option because customers usually receive meals, a room, entertainment options and access to some alluring ports of call for less than what it would cost to pay for those items separately. When flying the major airlines, you are lucky these days if you just get a bag of dry trail mix.
Fuel Costs Rising, Occupancy Rates Rising Too
Fuel costs have certainly taken a toll on the company. In its second quarter ended June 30, fuel costs came in at about $174.3 million. That's a big jump over the $126.1 million it spent on fuel in the same period last year. However, strong revenue and occupancy rates helped to pick up some of the slack.
In terms of its bottom line Royal Caribbean earned $84.7 million in the quarter, which was a drop from the comparable period last year's $129 million, but this was roughly in line with the prior forecast.
At present Wall Street is expecting the Miami-based company to produce earnings per share of $2.62 this year, and $2.67 a share next year. That's not a huge growth rate, but in the next five years the company is expected to grow at a roughly 11.1% pace per year, according to Yahoo Finance. That's not too shabby in my book, considering the shares can be had for about $26. Finally, the company pays a dividend with a dividend yield of 2.3%; this is a promising payout ratio of 23%.
The P/E Play
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.
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