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 preiod. 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 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, 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 of 1.0 suggests a valuation level above that of the broader market and a value below 1.0 suggests a valuation level below that of the market. (A further review of using relative P/Es can be found here.) 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, the P/E is, well, very valuable and should be a part of every investors’ toolkit.
Very often, 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.
Chevron (CVX – Free Analyst Report) is the world's fourth largest oil company based on proven reserves. Daily gross production in 2009 was 1.846 million barrels crude oil and Natural Gas Liquids and 4.989 billion cubic feet of natural gas. The company’s net proved reserves as of December 2009 were 6.973 billion barrels of oil and 26.049 trillion cubic feet of natural gas. Chevron also has over 4,000 owned or leased gas stations, mainly in the United States. It supplies over 11,000 other stations, as well.
Chevron reported huge second-quarter numbers, but second-half profits will likely taper off a bit. Indeed, the global economy appears to have a hit a speed bump. In addition, a large part of the company’s oil production stems from the Gulf of Mexico, where the U.S. government has imposed a moratorium in the wake of the BP (BP) oil spill. Should this imposition be extended beyond November, we think Chevron's production would be compromised. Ironically, however, the moratorium could aid Chevron's profits next year if oil prices move higher. The company is a high-quality stock with good long-term potential. A low P/E and a generous, growing, and very well covered dividend make the stock even more enticing. For a more detailed review of Chevron, see our free analysis of the company’s Value Line report.
Ford Motor Company (F) is the second-largest domestic automobile manufacturer; sales represented approximately 15% of the U.S. car and truck market in 2009. The company also engages in vehicle leasing and rental, and the manufacturing of electronic equipment. Its Financial Services Group, meanwhile, includes Ford Motor Credit and U.S. Leasing. Foreign operations accounted for about 52% of Ford’s 2009 sales. The estimated average age of the company’s plants is 10 years and it has about 200,000 employees. The Ford family, officers and directors own 1.5% of the stock, but have 40% of the voting power (as of the 4/10 Proxy).
Ford Motor should sustain sales momentum, though this may slow a bit, in the second half of 2010. The company posted a 35% top-line advance in the second quarter. We are encouraged by the carmaker's recent showing, but there is much uncertainty surrounding the near-term global auto sales picture. Still, the company has an impressive new model pipeline, which ought to help drive growth next year, while it continues to shore up its finances. Although there are sound reasons for Ford stock being cheap relative to the market, given its volatile history it remains an intriguing, though perennially risky, play on the auto market's recovery.
Aeropostale (ARO) is a mall-based specialty retailer that targets young women and men in the 11- to 20-year age range. The company's objective is to provide high-quality, active-oriented casual apparel and accessories at value prices. Its merchandise can only be purchased at company stores or organized sales events at college campuses. In 2009, Aeropostale operated almost 940 stores in 49 states and Canada. It also operates 14 “P.S. from Aeropostale” units. The average store size is 3,500 square feet and the company has more than 14,000 employees, about 75% of whom are part-time.
The top line continues to advance at a formidable pace for Aeropostale. In fact, the company benefited from a difficult economic environment, as consumers have been attracted to its lower-priced apparel. A well-received selection of merchandise, driven by strong inventory management, has supported customer traffic and purchases. Additionally, Aeropostale recently introduced online platform appears to be doing well. Over the longer term, the company’s efforts to continue its store base expansion should help spur earnings growth. The low P/E for this growing company seems out of place, as it potentially provides the opportunity to pick up a growing company that is besting its peers at a value price.
China Green Agriculture
China Green Agriculture (CGA), a stock on which Value Line recently initiated coverage, develops, produces, and distributes humic acid based compound fertilizer and other agricultural products in China. The company operates through its indirect, wholly-owned subsidiaries Techteam and Jintai. Fertilizer sales comprise approximately 82% of the company’s total. It sells over 145 different fertilizer products through a network of more than 500 regional distributors across China. Officers and directors own about 35% of the common stock, including CEO Tao Li’s 34.8% holding in the company (10/09 Proxy).
Revenues and share earnings at China Green Agriculture have advanced at a strong clip in recent years. We expect impressive growth in revenues and share earnings over the longer term, too, as the company expands internally and through acquisitions like its recent $22 million factory purchase. We expect this addition alone to materially increase the company’s production capacity, extend the its distribution network, and broaden the sales mix. Investors seeking exposure to the Chinese fertilizer market, noting the risk that such investment might entail, may find this fast growing, though relatively cheap, based on its P/E multiple, equity attractive.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.