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. 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 its stock is worth more because of the potential for future growth. Conversely, if a company’s earnings are growing slowly or unevenly, it wouldn’t make 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 1.00 suggests a valuation level above that of the broader market and a relative P/E below 1.00 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 and were chosen for their investment merit: Federal Mogul Corporation (FDML), Schweitzer Mauduit International Inc. (SWM), and Chevron Corporation (CVX – Free Chevron Stock Report).
Federal-Mogul is a global supplier of parts, modules, and systems for the automotive industry. Its main segments include: Powertrain Energy, Powertrain Sealings and Bearings, Vehicle Safety and Protection, and Global Aftermarket. Aftermarket products accounted for 34% of total revenues in 2011. The company has 200 facilities worldwide. North American operations generate approximately 40% of revenues, with 65% of that figure coming from aftermarket sales.
Federal-Mogul recently announced the retirement of its CEO. The surprise decision was announced in mid-March and became effective at the end of that month. The outgoing CEO and President, Jose Maria Alapont, had operated the company since 2005. Rainer Jueckstock, former senior vice president of the company’s Powertrain Energy unit, was named CEO on April 1st.
On another note, the company announced the decision to split its corporate structure. The board of directors has decided to create a separate, independent, Aftermarket division, and is currently seeking a CEO to fill this distinct business. The Aftermarket CEO will work independently and report directly to the board of directors.
Federal-Mogul is well positioned for the 3- to 5-year pull. The company’s balanced product mix and diversified geographic exposure may well help support steady increases in sales and earnings over the next few years. Notably, increased original equipment (OE) business has provided an opportunity for the Aftermarket unit to rebound. We look for the latter segment to continue to recover in the years ahead, given ample pent-up demand. FDML stock offers solid price-gains potential for the pull to 2015-2017 and currently trades at a below-market P/E multiple.
Schweitzer-Mauduit provides paper and reconstituted tobacco products for the tobacco industry. Its offerings include cigarettes, plug wrap and tipping papers, and reconstituted tobacco leaf. It sells tobacco products directly to the major tobacco companies or their designated converters worldwide. It operates in more than 90 countries with plants in Brazil, France, Indonesia, the Philippines, and the United States.
Schweitzer-Mauduit is dealing with another patent issue. The company has been fighting to block a German competitor, Julius Glatz and its LIPTec unit, from selling self-extinguishing cigarette papers in the U.S. An original decision in February stated that LIPTec didn’t violate SWM’s patent rights. Nevertheless, the U.S. International Trade Commission is currently reviewing the situation. Since SWM supplies 80% of these products to the United States, the protection of its patents is a necessary process for the company. A final decision is likely in early June.
We are cautiously optimistic regarding the company’s prospects for the next two years. Management is focused on repositioning its product portfolio toward higher-margined goods. It also looks to augment its market clout in Asia. Demand for Low Ignition Propensity (LIP) items may well remain strong, but we also expect better results at the Reconstituted Tobacco Leaf (RTL) division. SWM stock offers solid gains appeal for the 3 to 5 years ahead at its current valuation.
Chevron is the world’s fourth-largest oil company based on proven reserves. Its daily gross production in 2011 was as follows: crude oil and NGLs 1.849 million barrels; natural gas, 25,920 trillion cubic feet. Average 5-year finding costs are $5.43 a barrel (vs. industry average of $3.89). The 5-year reserve replacement rate is 95%, relative to the industry average of 109%. Estimated present value of reserves is $172.3 billion. Product sales are 4.5 million barrels per day. At year-end 2011, the company supplied directly or through retailers approximately 8,170 Chevron- and Texaco-branded motor vehicle gasoline service stations, primarily in the southern and western states. Approximately 490 of those outlets were company-owned or -leased stations.
We look for Chevron to build on its record-breaking 2011 performance. This is because we believe oil prices will remain north of $100 per barrel as the global economic recovery gains steam. We expect Chevron to boost its production, owing to more fields being mined. What’s more, natural gas prices, which have been flirting with multi-decade lows, might rise a little in 2012, due to greater demand for cheap, cleaner-burning fuel. Somewhat offsetting this good news might be an unsettled year for refining margins, reflecting lackluster demand and high oil input costs.
The outlook for the 3- to 5-year pull is solid. Chevron is embarking on a multitude of new oil, and oil-linked gas projects. The company has also entered into a number of global shale gas ventures, and is thus well positioned to capitalize on an upturn in the price of natural gas. These shares currently trade at a discount to the market P/E multiple.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.