It never hurts to go back to the basics, especially when markets are at today's current elevated levels. One of the most common used metrics in valuing a business is the price to earnings (P/E) ratio. Alone, the P/E ratio is not necessarily a 100% accurate indicator that a stock is cheap. But absent any special circumstances or one-time events at a company, a stock trading for 9 times earnings may likely be more attractive than a business trading at 35 times earnings. (For a quick refresher, check out P/E Ratio: Introduction.)
TUTORIAL: Ratio Analysis
Cheap by Commodity Standards
One quality blue chip name that shows up on the low P/E list is agricultural company Archer Daniels Midland (NYSE:ADM). Trading near $35, ADM has a market cap of $22.5 billion and a current P/E near 12. In addition, the stock yields a decent 1.8%. If agricultural commodities remain robust, the company's business of transporting, storing and processing corn and wheat should do well. In addition, continued strong demand for grains and ethanol increase the need for ADM's services. (For more, see Archer Daniels Midland Casts A Wide Net.)
Staying with commodities, Cliff Natural Resources (NYSE:CLF) is the largest producer of iron ore pellets in the United States. In addition, the company is a significant producer of metallurgical coal in Australia. Shares trade at 12.5 times earnings, significantly below many of its peers. CONSOL Energy (NYSE:CNX) trades at 34 times earnings while giant coal producer Peabody Energy (NYSE:BTU) commands a P/E of 25, respectively. Cliffs generates an impressive 28% net profit margin and an essentially unlevered return on equity of 32%.
Stocks for Thought
It's not uncommon for troubled companies to have a low P/E ratio. If the problems with the business can't be fixed, then a low P/E is a value trap. But if the company can successfully execute a turnaround, and it has the capable management to do so, then such investments can be diamonds in the rough. Electronics retailing giant Best Buy (NYSE:BBY) seems to fit the "diamond in the rough" mold.
Every so often, the electronics industry goes through a point in its cycle where few customers need to upgrade any electronic equipment. This seems to be the case now and as a result, shares are trading under 9 times earnings. Best Buy has proven that it can compete with Wal-Mart (NYSE:WMT), but more importantly, Best Buy offers a lot that Wal-Mart simply cannot. Shares were battered this week when Best Buy reported that fourth quarter profits declined by 16% and investors became concerned with the future outlook. To be sure, shares could drop further before advancing but that would merely make the business cheaper to own. (For more, see 5 Stocks At 52-Week Lows.)
The Bottom Line
Although a low P/E ratio is not a blanket confirmation that a business is undervalued, it is a great starting point for inquisitive investors. (For more, see Getting On The Right Side Of The P/E Ratio Trend.)
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