Having a low price-to-earnings ratio is no guarantee of investment success. Nevertheless, all else equal, companies trading at lower multiples to earnings tend to do well over the longer term. During such periods, however, investors should be comfortable with periods of underperformance.
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You won't find sizzling growth and profit numbers from these names like you will from names like Apple (Nasdaq:AAPL) and Amazon (Nasdaq:AMZN). At the same time, you won't find yourself paying P/E multiples of 130+, either. Investors paying such lofty multiples are making extremely confident bets that growth rates of 30-50% can be sustained for a prolonged time. While Apple's innovative products continue to defy the most bullish expectations, as those expectations rise, even great numbers can be disappointing. Nothing is more frustrating to an investor than when a company reports profit growth of 20%, but the stock declines because analysts were expecting 30% instead.
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So, with a quality stock trading at a low multiple, many of those hurdles are overcome. The key, of course, is to not get sucked in by a P/E that looks low and only gets lower. Growth is a component of value, and if a company cannot grow its business successfully, the valuation might not matter.
Part Of The Pack
Being members of the S&P 500 index adds credibility that these are no fly-by-night companies. Western Digital (NYSE:WDC) is a $7 billion business with a forward P/E of 3.29. Even better, the company has over $3.4 billion in net cash on the balance sheet. The one question mark for investors is that WDC designs and builds hard drives - products that are always in need of upgrades and innovation. Translated: WDC operates in a very competitive industry. Yet so do many other competitors that trade at greater valuations.
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Eli Lilly (NYSE:LLY) may be one of the cheapest names in the S&P 500. Aside from an 11 P/E, shares currently yield just under 5 percent. Few, if any, companies have both an attractive valuation and an enormous payout. The company is one of the most significant drug manufacturers in the world with a bond-like yield and equity upside at a decent multiple to future earnings.
As the price of natural gas has recently declined, so have shares of Chesapeake Energy (NYSE:CHK), a $11.5 billion natural gas giant. Natural gas is an extremely abundant resource in the U.S. and has significant environmental benefits over oil and coal. Trading at around 11 times forward earnings, Chesapeake's natural gas assets are worth far more than today's price in a normal environment. Indeed, prolonged periods of low natural gas prices will not bode well for the stock, but value is not a short-term game.
Electronics retailing giant Best Buy (NYSE:BBY) continues to face sales headwinds at its U.S. store base. This $6.7 billion company is currently trading at 5.3 times forward earnings. The most recent quarterly earnings report indicated a slight sales declines but if they recover the shares are worth a closer look.
There are still some quality blue chip-like names that offer decent valuations in terms of their P/E ratios and, in some cases, they offer excellent yields. That's a recipe for quality returns in exchange.