How can you define what makes a business both cheap and safe as an investment? It depends on who you ask, but the P/E ratio and debt-to-equity ratio are a good place to start. Despite its limitations, the P/E ratio is a good proxy of how cheap or expensive a company's valuation is at any given time, while in terms of safety, a sound balance sheet is your guidepost. Under these assumptions, I've screened for stocks with P/E ratios below 12 and debt to equity ratios of 30% or less. Let's take a look at some of the safest stocks that are selling at affordable valuations now.(For background reading, see The Value Investor's Handbook.)
The Best Big Companies
Although the markets are entering their third year of a bull phase, screening for stocks based on their P/E and debt-to-equity ratios still yields plenty of names. From this list, I've attempted to eliminate any one-trick ponies; these are companies with one year of out-sized profits due to a non-recurring event. They may have low P/Es today, but they aren't reliably cheap and safe stocks. The list, as you might imagine, includes some of the biggest names in industry. One in particular, Microsoft (Nasdaq:MSFT) is hard to ignore. Shares trade for 11 times earnings and under 10 times forward earnings. Trading at $24 a share, cash per share is nearly $5. In addition, you get 64 cents a year in dividends for a yield of 2.5%. (For more, see Dividend Facts You May Not Know.)
Another large candidate is Posco (NYSE:PKX), one of the largest steel companies in the world. Based in South Korea, Posco has one of the lowest cost structures in the industry, one of the only advantages available to a commodity-type business. Posco's operating margins are nearly 11% - 50% greater than Arcelor Mittal (NYSE:MT), the largest steel company in the world. Posco trades for 8 times forward earnings. Total debt is $11 billion against equity value of around $34 billion.
On the smaller side, snack-food company China Marine Food (NYSE:CMFO) continues to execute. For the 2010 calendar year, revenue and net income grew by 77% and 43% respectively. The company has $15 million in cash and no debt. Shares trade at $4.75, or 7 times earnings.
Gamestop (NYSE:GME) is an electronics store retailer that sells both new and used video games and related equipment. The company has built a great model since loyal gamers want to be able to trade in played games for others. Shares trade for less than 7 times earnings and the company has minimal debt.
Not an Automatic Buy Signal
Low P/E stocks are attractive. Low P/E stocks with great balance sheets are even more attractive. However, you must go through several more layers of analysis to ascertain whether those two qualities make for a truly undervalued stock. The "cheap and safe" screen just gives you a head start.
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