Despite its simplicity, the P/E ratio is one of the most commonly used valuation tools in the market today. The ratio gives investors an easy and quick way to compare how much people are currently paying for every dollar of a company's earnings. (For a primer on this ratio, see our P/E Ratio Tutorial.)

IN PICTURES: 5 Investing Statements That Make You Sound Stupid

The most appropriate way to use the P/E ratio is to compare a company's P/E ratio to the average P/E of all the companies that make up the industry or sector the company is in. Companies that trade at a low P/E ratio to the industry may be relatively undervalued. In addition, the ratio should be compared to the average P/E of the company itself going back a few years, such as a five-year average P/E. As long as there hasn't been any fundamental shift in the business, this is a good way to support the analysis.

With that said, let's take a look at some large cap stocks that have relatively low P/E's and may provide an opportunity going into 2011.

Company Ticker P/E
Lockheed Martin Corp NYSE:LMT 9.8
Honda Motor Co. NYSE:HMC 9.7
ConocoPhillips NYSE:COP 9.5
Eli Lilly Compay NYSE:LLY 8.1
WellPoint Inc NYSE:WLP 5.0

Lockheed Martin
This stock appears to be one of the more interesting companies on this list for a few reasons. First, the company pays a great 4.4% dividend yield, which is quite high considering the extremely low interest rate environment, and yields on comparable stocks. The quality of the dividend is also quite good, illustrated by its consistent rise from $0.44 in 2000 to $2.34 in 2009 and low payout ratio of 30%.

Second, in terms of valuation, the stock is trading at the lowest price-to-earnings multiple it has had over the past 10 years, currently at 9.8 versus the industry average of 12. Also, the fiver-year average P/E for Lockheed is approximately 13.3, suggesting there is quite a bit of room for the stock to move. Lastly, the increasing tensions between North and South Korea, although unfortunate, can serve as a catalyst for defense contractors over the medium term. Currently, Lockheed trades at just under $70, but this would be a good stock to keep an eye on in the next year.

The Bottom Line
The P/E ratio should not be used as the only tool to base an investment decision on. Sometimes a low P/E may be justified simply due to the deterioration of the business and expected low earnings going forward. However, as a starting point, the P/E is one of the quickest and easiest ways to spot a potential bargain.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center