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 is to show how much an investor is paying to own that particular stream of earnings.
If a company’s earnings are growing strongly, 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 or unevenly, 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, 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 one suggests a valuation level above that of the broader market and a relative P/E below one suggests a valuation level below that of the market. Another common comparison is to consider the current P/E versus a company’s historical P/E ratio. 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, a 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.
The Travelers Companies (TRV - Free Travelers Stock Report), formerly called St Paul Travelers, is a leading provider of commercial property/casualty insurance and asset management services. Following the April, 2004 acquisition of (the former) Travelers, the company is now the leading underwriter of homeowners insurance and automobile insurance through independent agents.
Travelers registered healthy results for the December quarter. The P/C insurer posted operating share net of $1.89 (excludes capital gains and losses) that, although comparing unfavorably to the prior-year’s tally of $2.12, was higher than our estimate of $1.68. The top line increased modestly from the previous year’s figure, as the company benefited from a decent pricing environment, along with new business wins. Moreover, net investment income was fairly stable relative to 2009, which is quite impressive. The company benefited from strong cash flow, which aided invested assets. This helped to counteract reduced bond yields. The combined ratio was a profitable 90.6% for the interim.
Looking forward, we expect the company to earn $6.20 a share this year. This is a slight decrease from last year, however this doesn’t surprise us given the current state of affairs in the insurance industry. Intense competition has made price hikes difficult to come by. However, management noted in its December-period conference call that the operating climate is better than it originally thought. Consequently, we look for a slight uptick in premiums earned this year. On the other hand, the loss ratio is likely to increase, as weather-related catastrophes, which have been abnormally low over the past few years, will probably approach their historical average.
Power-One (PWER) makes power supplies for use in communications, automatic testing, medical, industrial, and other electronic equipment. Its products are sold through electrical component distributors. The company’s original equipment manufacturer customers include Cisco (CSCO – Free Cisco Stock Report) and Teradyne (TER), among others.
Power-one stock has performed poorly of late. The lackluster investor sentiment probably stemmed from lower expectations for full-year sales growth in 2011. Although demand for power inverters has been strong, the near-term outlook has been scaled back. Management looks for moderating growth for the first half of this year, due to cutbacks on feed-in-tariffs (government subsidies) in Italy and Germany, as well as an oversupply of inverters in Germany. As a result, Power-One is eyeing other markets for growth. It opened a manufacturing plant in Arizona last year and is also conducting research endeavors there. What’s more, it intends to roll out regionally specific products in China by the end of this year. Too, bookings in India for solar and other renewable energy products have been initiated. Going forward, global expansion efforts ought to enable the top and bottom lines to climb at a solid annual rate.
Suntech Power ADS (STP), through its subsidiaries, engages in the design, development, manufacture, and marketing of photovoltaic (PV) cells and modules. It also provides PV system integration services in China. The company’s products are used for various residential, commercial, industrial, and public utility applications for on-grid electricity generation, as well as for off-grid use, such as mobile phone networks. Products are sold to solar distributors, engineering & design firms, installers, system integrators, and property developers.
Suntech Power is riding strong momentum right now. The backdrop in the solar power arena was already growing increasingly favorable. Selling prices were climbing, and demand for new and existing projects was on the rise. STP’s sales have been on a solid upward trajectory, and the expansion of its wafer capacity is scheduled to continue. Then, the earthquake struck Japan in March and all the headlines were about the issues at that country’s nuclear power plants in the regions affected. These developments have led to a lot of attention for solar energy alternatives, and prompted almost all companies in this field to realize solid increases in their valuations. What’s more, we look for expense reductions to come to fruition in the coming quarters. Cell and module processing costs are decreasing, and the cost of producing wafers should begin to decline in tandem. If the company’s projections for its layouts pan out for 2012, STP would likely be one of the top low-cost producers of photovoltaic devices in the world.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.