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 stream 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, an individual 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 (you can see a sample here) 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 at a high price and pinpoint the ones that are trading relatively inexpensively. As a valuation tool the 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.
Corning Inc. (GLW) produces specialty glasses, ceramics, and related materials, primarily for industrial and scientific applications. The company has five operating segments: Display Technologies (40% of 2011 sales) makes glass substrates for liquid crystal displays (LCDs), that are used in notebook computers, desktop monitors, and LCD televisions; Telecommunications (25%) makes optical fiber and cable, and hardware and equipment; Environmental Technologies (13%); Specialty Materials (14%); and Life Sciences (8%). Research and Development expenses totaled $562 million in 2011 or 8.7% of sales.
Corning encountered a challenging operating landscape last year, particularly toward the back half. Demand was weaker than expected due to overall macroeconomic difficulties and pricing pressures. Yet, despite such obstacles, the company managed to post sales growth in all of its five operating segments. The top-line expansion was partly due to new products such as Lotus Glass, an environmentally friendly, high-performance display glass.
Moving forward, we expect near-term share-net growth to be lackluster since demand trends remain weak. But management is taking actions such as the reduction of manufacturing capacity, in order to curb operating costs. Furthermore, we are optimistic that certain initiatives will bear fruit over the long term. Indeed, new products will likely gain more prominence in the 3- to 5-year span. And an improved economic landscape ought to facilitate heightened consumer spending for glass- and ceramic-related goods such as large screen televisions.
The stock has worthy attributes such as solid 3- to 5-year price appreciation potential. And shareholders ought to continue to benefit from dividend payments. Furthermore, the strong balance sheet should allow for greater capital spending projects when the economy fully rebounds.
The Pantry (PTRY) is a chain of convenience stores based primarily in the southeastern United States. The company offers a range of merchandise including cigarettes, grocery items, packaged beer, and wine. In addition, it sells fuel and other ancillary products. The Pantry operates under several banners including Kangaroo Express. At the end of fiscal 2011 (year ended September 24th, 2011) the company operated 1,649 stores in 13 states. At yearend, gasoline sales accounted for 75% of the top-line figure and merchandise, 25%.
The company is well positioned for a comeback over the next two years. Fiscal 2011 was particularly difficult due to hefty impairment charges and a rise in wholesale gasoline costs. These factors translated to a lackluster earnings performance last year. That said, 2012 and 2013 should bring better results for several reasons. First, PTRY is working assiduously to improve the decline in gasoline volume, brought about by the per-gallon price hikes. While there has not been any data that suggest short-term improvement in fuel demand, the company remains committed to improving its comparable gallon performance by increasing its share of the market. Although near-term drawbacks are expected, this initiative ought to inevitably enhance profitability.
In addition, the company is seeking to improve the operational performance of its stores by strategically opening and shuttering facilities where necessary. For example, it is in the process of divesting about 200 stores, while adding to its lineup in other underpenetrated regions. Although the company is not fully insulated from macroeconomic pressures, these moves are good, in our view, because they allocate capital spending in an efficient manner.
Meanwhile, the solid balance sheet is a plus. The company had over $150 million in cash at the end of 2012’s first fiscal quarter. And although the debt balance is high, the figure is manageable and it is comforting that PTRY is focused on reducing its debt level. At the current quotation of $12.01, the shares appear to be undervalued. Appreciation potential to 2015-2017 is above average, and assuming divestments and the revamping of certain locations are successful, PTRY is poised to rebound.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.