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.
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 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 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 is information on one company that was recently found on this list, Vishay Intertechnology (VSH).
Vishay Intertechnology is a major U.S. and European manufacturer of passive electronic components, such as resistors, capacitors, and inductors. The company also produces semiconductors and stress sensors. The bulk of Vishay’s revenues (approximately 74%) are derived from overseas operations, as heightened global demand has been a key fundamental driver over the past few years. Its primary customers include distributors (52%), original equipment manufacturers (42%), and electronic manufacturing services companies (6%).
Like many other electronic component outfits, Vishay’s earnings have exhibited a fair degree of volatility in recent years due to macroeconomic instability. Subsequent to the 2008 financial crisis, which greatly depressed Vishay’s bottom-line figures, the company registered exponential earnings growth. Similarly, VSH’s share price has experienced a nice upswing, given its noteworthy return to profitability. That said, the company may still be characterized as inexpensive relative to the broader market, as well as to its historical norms. Many investors use a commonly known ratio, price to earnings, to evaluate a company’s attractiveness, in terms of its relationship between share price and its earnings streams. According to our model, Vishay Intertechnology is trading around 10x our forward-looking 12-month earnings-per-share estimate. With a historical average annual price to earnings ratio of 13.5 and a broader market average P/E of roughly 17, value investors may find these shares particularly appealing at this juncture. On top of that, risky tech stocks such as VSH may face relatively severe downward price pressure owing to a sell-off in the broader markets, not necessarily due to the company’s financial performance. This would further boost the stock’s attractiveness, from a price-to-earnings standpoint. In sum, equities trading at lower multiples, comparatively speaking, tend to have more room to run over the 6 to 12 month time frame.
Moreover, we are fairly bullish on the company’s earnings prospects over the long haul. A pickup in the automotive and industrial industries, Vishay’s two largest markets, should provide a solid platform for sustained growth. Too, Vishay has been active on the acquisitions front, looking to widen its scope and strengthen individual operating segments. Lastly, an improving macroeconomic landscape further down the road augurs well for long-term prospects. In fact, we think Vishay can more than double it’s bottom-line over the next 3- to 5-years. Indeed, expanding earnings may well attract value-oriented investors (low P/E seekers) to this equity for quite some time.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.