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 Price* P/E*
Build-A-Bear Workshop
(NYSE:BBW)
$8.34 8.2
Jackson Hewitt
(NYSE:JTX)
$13.18 10.0
BP PLC
(NYSE:BP)
$68.50 9.5
Marathon Oil
(NYSE:MRO)
$50.83 9.0
Valero Energy
(NYSE:VLO)
$44.60 5.8
* Market data as of June 10, 2008.

You should notice that three out of the five stocks are oil stocks. The oil sector traditionally trades at a lower P/E compared to the market, as does the financial sector. There are plenty of names in the financial sector that could have been put up here, but with many of their earnings still deteriorating, it significantly raises the risk in this style of investing.

Out of the oil stocks, Valero stands out as the steepest discount purely based on P/E. Don't be too quick to hit the buy button, however. The stock is trading lower than its peers because its earnings are expected to drop. Still the stock is at such a low P/E, that picking up some shares looks wise.

Marathon is also a strong presence in the oil sector and is trading at a discount. When the companies are of good quality, it is important to look longer term. The P/Es of solid companies like Marathon tend to move toward their industry average P/E, unless circumstances change. When the P/E does regulate, the payoff to shareholders can be great.

Build-A-Bear is a stock that has experienced some problems recently, including a downgrade from Credit Suisse due to poor sales. The problems are real, but are they permanent? The stock is trading at a point where it may take a while to go up, but the downside risk has been limited. It could turn out to be an attractive long term play.

Conclusion
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.

Looking for low P/E ratios is a great way to find the next great value pick. To learn more on this and other strategies, read out Guide To Stock Picking Strategies.

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