One way in which stocks are valued is the price to earnings ratio, commonly abbreviated as P/E or p/e. It is a fairly simple calculation that divides a stock’s price by the company’s earnings per share for a given 12-month period. The logic of the ratio is that by owning a share of a company you are, arguably, buying the future steam of earnings the company generates. The idea of the P/E ratio is to show how much an investor is paying to own that particular stream of earnings.
If a company’s earnings are growing quickly, investors might logically assume that today’s earnings are worth more because of the potential for future growth. Conversely, if a company’s earnings are growing slowly, it wouldn’t make logical sense to pay a premium. This last statement highlights an important aspect of the P/E ratio—by itself it provides minimal information. To properly use the P/E as a valuation tool it must be compared to something.
In many cases, a P/E is compared to the average P/E of the broader market. Value Line publishes the P/E of the market each week for this very purpose. Moreover, each Value Line research report contains both the actual P/E and the company’s relative P/E. A relative P/E above 1.00 suggests a valuation level above that of the broader market’s and a figure below 1.00 suggests a valuation level below that of the market’s. Another common comparison is to consider the current P/E versus a company’s historical P/E ratios. This information is provided in the historical section of the Statistical Array on each Value Line report. Price to earnings ratios can also be compared between peers, to spotlight the companies in an industry that are trading dearly and pinpoint the ones that are trading relatively inexpensively. As a valuation tool P/E is, well, very valuable and should be a part of every investors’ toolkit.
Very often, the P/E is best used to simply cut companies from a list of research candidates. It is, indeed, a quick way to pull out companies that are trading relatively cheaply from a much wider group. To this end, each week The Value Line Investment Survey contains a listing of the 100 companies with the lowest Price to Earnings ratios out of the approximately 1,700 followed by the service (it is paired with a similar screen for the highest P/Es). For value-oriented investors, this list of low Price to Earnings ratio stocks is a great place to start looking for investment ideas. Below are a few companies that were recently found on this list.
Genco Shipping & Trading Limited (GNK) operates a fleet of some 53 drybulk vessels with a total capacity of about 3.8 million tons. Vessel capacity increased 31% in the first half of 2010. The company’s business strategy is to charter these vessels to large entities for periods of one to five years and to continually expand the fleet. The cargo generally transported is coal, iron ore, and grain, and the main shipping routes are from Australia, Brazil, and Argentina to China and India.
While near-term profits are being restricted by lower average shipping rates, we project earnings growth during the 2013–2015 period. The dearth of new shipbuilding orders over the past year and the likelihood of a continued rise in exports of iron ore and coal to China are key factors behind our projections.
Genco is in a relatively favorable position within the dry bulk shipping industry. The average age of its vessels is about 6.5 years, which is less than half the industry average. Also, the fleet covers all classes of ships, and its diversity should continue to be a leasing advantage. Finally, Genco’s estimated free cash flow is superior to most of its peers. The last factor suggests that the company is well positioned with regard to vessel acquisitions.
US Airways Group (LCC) provides air transportation for passengers and cargo. The company operates approximately 3,100 flights daily to 200 communities in the United States, Canada, Europe, the Caribbean, and Latin America. The airline operates around 349 mainline jets supported by its regional airline subsidiary, US Airways Express. Flight operations are organized over a hub-and-spoke network with hubs in Charlotte, Philadelphia, and Phoenix.
In 2010, the airline probably generated its first yearly profit since 2007, and we look for a moderate earnings gain in 2011. The company’s top and bottom lines are benefiting from the general economic recovery (albeit sluggish), increased ancillary revenue (derived from baggage and other fees), industry-wide capacity discipline (fewer available seats mean higher load factors), and a pickup in high-margined international business travel (which yields more premium fares). However, while the near-term outlook for US Airways is enhanced by positive fundamentals, the equity carries considerable risk, due to its heavy debt structure and exposure to oil price fluctuations.
Petroleo Brasileiro (PBR), commonly referred to as Petrobras, is an integrated petroleum company, primarily operating in Brazil and other parts of South America. However, it is increasingly diversifying into North America and Europe. The company’s average daily production exceeds 2.1 million barrels of oil and 2.5 billion cubic feet of natural gas. Crude oil net proved reserves are more than 10.3 billion barrels, while natural gas net proved reserves are over 11.0 trillion cubic feet. The company also owns and operates 11 refineries in Brazil.
Favorable short-term fundamentals are being driven by higher commodity prices and increased production levels. In addition, the intermediate-term outlook should be enhanced by the drilling potential of certain fields located off the coast of Brazil and by the healthy demand possibilities of the company’s refining business. Petrobras recently raised $70 billion via a public offering of common stock and preferred shares, which means that management should have plenty of money to finance its aggressive expansion plans. One caveat for investors is that the stock price is sensitive to changes in oil and gas prices.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.