The price-to-earnings (P/E) ratio is one of the most widely-used metrics for quick stock valuations. The ratio is relatively easy to calculate and tells investors what one share costs for every one dollar of earnings. The P/E ratio also has a significant relationship with long-term stock returns, so despite its simplicity, it is a great starting point for stock analysis. (To learn more, check out our P/E Ratio Tutorial.)
Comparing P/E Ratios
P/Es of comparable companies should generally be the same, unless company-specific factors considerably change the outlook of the company. 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 that are 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||Dividend Yield|
|AstraZeneca plc (NYSE:AZN)||9.5||7%|
|Aceto Corp. (NYSE:ACET)||10||3.3%|
|Bristol Myers Squibb (NYSE:BMY)||7.5||6.2%|
|PDL BioPharma (Nasdaq:PDLI)||7.5||13%|
|Merck & Co. (NYSE:MRK)||9||6.1%|
|Data as of market close June 17, 2009|
Picking the Winner
With whispers of a sideways market, or even a retraction in the near future, placing your money into non-cyclicals such as drug manufacturers might let you hold onto some of those gains you made over the last three months. Finding the right ones is a little trickier. The P/Es of these stocks aren't amazingly low, but they are below the average. Add in the dividend yield of between 3% to 13% and you start to see value in ownership.
Bristol Myers is a solid pharm company with a global reach in its product sales. The board of directors just declared a 31-cent quarterly dividend for shareholders of record on July 6, 2009. At current stock prices, holders are getting about 6% yield from the distributions. Earnings expectations for 2009 give a forward P/E of about 10, still below the industry average.
Good News in the Pipeline
On June 12, 2009, Bristol Myers Squib announced good results from two ORENCIA (abatacept) trials. The long-term study demonstrated the drug's capacity for beneficial change in rheumatoid arthritis (RA) patients. It is used as an addition to the common treatment for RA (methotrexate) and could remain as a treatment for the rest of the patient's life.
PDL BioPharma manages biotech patents and royalty assets. It pays out the royalties of $1/share, which have been maintained through the second dividend declared as 50 cents per share to holders of record on September 17, 2009. A 13% dividend yield should entice investors. The assets on which the income is based will expire between 2013 and 2014.
Merck just released a proxy statement declaring that the boards of directors have approved a merger agreement with Schering-Plough. The combined company will create a healthcare giant. The statement reaffirmed the 38 cents per share dividend for Merck. Both companies are working to close the merger in the fourth quarter of 2009, but unforeseen circumstances could cause delays.
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.)