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Tickers in this Article: TER, COT, PPD, OSK, GME, BBY, WMT
Making investment decisions within an expansive and dynamic market can be intimidating to the individual investor. The process of whittling down the entire universe of publicly traded stocks into a single successful stock selection can seem like a truly overwhelming task.

To make matters worse, choosing a winning stock once does not a successful investor make. Individual investors must continually make correct decisions over long periods of time if they are going to be able to beat the market averages. For many, this often proves too difficult a task, as investors must remain level-headed and act rationally over long periods of time, even as the human emotions of greed and fear take turns driving the market's collective direction.

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Bounded Irrationality
Rather than attempt super-human feats rationally, a feasible solution for the individual investor is to limit the opportunity for irrationality and emotional thinking to impact investment decision-making. This is accomplished by adhering to a logical investment methodology, such as only purchasing stocks that meet specific investment criteria, such as a low P/E ratio.

Research has shown that stocks with significantly low P/E ratios, on average, outperform the overall market. While some stocks that have low P/E ratios will turn out to be justifiably cheap, an entire portfolio of low P/E stocks will be likely to do better than the market average, and have less downside risk as well. On that note, here are five stocks with low P/E ratios that are worth a look:

Company Market Cap Trailing P/E Forward P/E
Teradyne (NYSE: TER) $1.8 B 9.8 5.0
Cott Corporation (NYSE: COT) $460 M 6.1 7.2
Pre-Paid Legal Services (NYSE: PPD) $515 M 9.4 8.1
Oshkosh Corporation (NYSE: OSK) $2.6 B 3.1 8.3
GameStop (NYSE: GME) $3.0 B 9.0 7.0


Cheap Today, Expensive Tomorrow?
While a portfolio of low P/E stocks will likely be undervalued in aggregate, some of the individual stocks will probably be accurately priced, or worse, overpriced. Investors should attempt to weed out the stocks most likely to be overpriced, and an obvious starting place are those stocks that are only carrying low trailing P/E ratios because their earnings are expected to decrease in the future. (Learn more about using P/E ratios in Profit With The Power Of Price-To-Earnings.)

This scenario is exhibited by Oshkosh Corporation and Cott Corporation. Oshkosh's trailing P/E is a minuscule 3.1, but its forward P/E currently sits at 8.3, as its net earnings are expected to drop off considerably for its 2011 fiscal year compared to 2010. Similarly, Cott Corporation's forward P/E is higher than its trailing P/E as its current fiscal year is expected to tally only 72 cents worth of EPS, compared to 79 cents from the year before. All else being equal, these stocks are less likely to be undervalued than stocks whose forward P/Es are lower than their trailing P/Es.

Growth At a Reasonable Price
On the other hand, the other stocks in this shortlist, Teradyne, Pre-Paid Legal Services, and GameStop all have forward P/E ratios that are significantly lower than their trailing P/Es. While not a guarantee of undervaluation, and keeping in mind there are many other factors to be considered, this situation increases the probability that these stocks are in fact trading below fair value.

GameStop in particular exhibits strong growth expectations, while trading at a reasonably low P/E valuation. For its current fiscal year (ending in January 2011), analyst consensus estimates peg the company to earn $2.63 per share, representing a 15.9% increase from the previous year's $2.27 earnings per share. The following fiscal year's consensus estimate calls for further growth to $2.87 per share. In spite of these expectations, the stock trades at lower trailing P/E to significant competitors, as Best Buy's (NYSE: BBY) trailing P/E is currently 11.0 and Wal-Mart's (NYSE: WMT) sits at 13.5.

The Bottom Line
While any given stock trading at a low P/E ratio may turn out to be cheap for a valid reason, on average, an entire portfolio of low P/E stocks has a good chance of being undervalued in aggregate, and thus outperforming the overall market as its valuation eventually increases. That said, logical selection of stocks that have good growth expectations while still carrying low P/E ratios, such as is currently the case GameStop, decrease the odds that one of your low P/E stocks will turn out to be a loser. (To learn more, check out The P/E Ratio: A Good Market-Timing Indicator.)

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