The worse a company performs, the better value its stock will appear to be.
Because declining fundamentals will prompt a company's shareholders to sell, the price will decline. This will cause all the value indicators to show that the price has become a bargain. It's not.
Showing posts with label low PE. Show all posts
Showing posts with label low PE. Show all posts
Saturday, 22 December 2012
Sunday, 17 June 2012
Stocks with Low PE Multiples Outperform those with High Multiples. Investors are warned repeatedly about the dangers of very high-multiple stocks that are currently fashionable.
In 1934, Dodd and Graham argued that "value" wins over time for investors. To find value, investors should look for stocks with low PE ratios and low prices relative to book value, P/BV. Value is based on current realities rather than on projections of future growth. This is consistent with the views that investors tend to be overconfident in their ability to project high earnings growth and thus overpay for "growth" stocks.
Stocks with Low PE Multiples Outperform those with High Multiples
One approach of stock selection is to look for companies with good growth prospects that have yet to be discovered by the stock market and thus are selling at relatively low earnings multiple. This approach is often described as GARP, growth at a reasonable price.
Earnings growth is so hard to forecast, it's far better to be in low-multiple stocks; if growth does materialize, both the earnings and the earnings multiple will likely increase, giving the investor a double benefit. Buying a high-multiple stock whose earnings growth fails to materialize subjects investors to a double whammy. Both the earnings and the multiple can fall. Therefore investors are warned repeatedly about the dangers of very high-multiple stocks that are currently fashionable.
There is some evidence that a portfolio of stocks with relatively low earnings multiples (as well as low multiples of cash flow and of sales) produces above-average rates of return even after adjustment for risk. This strategy was tested and had been confirmed by several researchers who showed that as the PE of a group of stocks increased, the return decreased.
This "PE effect," however, appears to vary over time - it is not dependable over every investment period. And even if it does persist on average over a long period of time, one can never be sure whether the excess returns are due to increased risk or to market abnormalities.
And low PEs are often justified. Companies on the verge of some financial disaster will frequently sell at very low multiples of reported earnings. The low multiples might reflect not value but a profound concern about the viability of the companies.
Stocks with Low PE Multiples Outperform those with High Multiples
One approach of stock selection is to look for companies with good growth prospects that have yet to be discovered by the stock market and thus are selling at relatively low earnings multiple. This approach is often described as GARP, growth at a reasonable price.
Earnings growth is so hard to forecast, it's far better to be in low-multiple stocks; if growth does materialize, both the earnings and the earnings multiple will likely increase, giving the investor a double benefit. Buying a high-multiple stock whose earnings growth fails to materialize subjects investors to a double whammy. Both the earnings and the multiple can fall. Therefore investors are warned repeatedly about the dangers of very high-multiple stocks that are currently fashionable.
There is some evidence that a portfolio of stocks with relatively low earnings multiples (as well as low multiples of cash flow and of sales) produces above-average rates of return even after adjustment for risk. This strategy was tested and had been confirmed by several researchers who showed that as the PE of a group of stocks increased, the return decreased.
This "PE effect," however, appears to vary over time - it is not dependable over every investment period. And even if it does persist on average over a long period of time, one can never be sure whether the excess returns are due to increased risk or to market abnormalities.
And low PEs are often justified. Companies on the verge of some financial disaster will frequently sell at very low multiples of reported earnings. The low multiples might reflect not value but a profound concern about the viability of the companies.
Friday, 15 June 2012
What should you do if you find that the price or P/E is significantly above or below the historically fair price or fair P/E mark?
"It is better to buy a wonderful company at fair price than a fair company at wonderful price."
In general, if you can buy a quality stock today for a historically fair price or fair P/E, you should probably do so, provided the reward and risk are attractive.
However, what should you do if you find that the price or P/E is significantly above or below the historically fair price or fair P/E mark?
A low price or low P/E is probably your biggest concern, because it suggests that people who are buying the stock today might know something negative about the company that you don't know.
Think about it. Why would investors pay less for the stock than it has typically sold for?
If the price or P/E is too low - move on to another company and forget about looking at the risk and reward. You may miss a few good stocks, but you won't have to lose any sleep worrying about being wrong.
If the price or P/E ratio is too high, this tells you two things.
(E.g. _____________)
Just know that, if you buy a stock whose price or P/E is too far above the fair price or fair P/E, when it later comes back down - which it usually will - the decrease in P/E can reduce your gain considerably. Your chances of having a superior portfolio are far better if you select stocks for which you don't have to make any allowances.
As you gain more experience, you'll find that you can make some intelligent exceptions in cases of high or low price or P/E, but for now, the advice for those who are just starting out, don't.
In general, if you can buy a quality stock today for a historically fair price or fair P/E, you should probably do so, provided the reward and risk are attractive.
However, what should you do if you find that the price or P/E is significantly above or below the historically fair price or fair P/E mark?
A low price or low P/E is probably your biggest concern, because it suggests that people who are buying the stock today might know something negative about the company that you don't know.
Think about it. Why would investors pay less for the stock than it has typically sold for?
- Is there something in the news that you haven't heard about?
- Has an analyst - or have a number of analysts - announced a reduced expectation of future earnings based upon something they know that you don't know?
- Have you missed something in your quality analysis - or (shame on you!) recklessly jumped over that barbed-wire fence, failing to evaluate quality deliberately enough before moving on to look at the value considerations?
If the price or P/E is too low - move on to another company and forget about looking at the risk and reward. You may miss a few good stocks, but you won't have to lose any sleep worrying about being wrong.
If the price or P/E ratio is too high, this tells you two things.
- The first is that other investors appear to agree with you about the quality issues, because they are paying a healthy price for the stock.
- The second is that it may be too healthy a price.
- You may want to put off buying it until the price becomes more reasonable.
- Or, it may be worth the premium if the risk and reward are satisfactory.
(E.g. _____________)
Just know that, if you buy a stock whose price or P/E is too far above the fair price or fair P/E, when it later comes back down - which it usually will - the decrease in P/E can reduce your gain considerably. Your chances of having a superior portfolio are far better if you select stocks for which you don't have to make any allowances.
As you gain more experience, you'll find that you can make some intelligent exceptions in cases of high or low price or P/E, but for now, the advice for those who are just starting out, don't.
Monday, 6 February 2012
A Subnormal P/E
When a stock is selling at a P/E significantly lower than that of its competitors, an investor will want to know why?
A low P/E does not necessarily mean higher risk, though the company should be studied with that possibility in mind.
On the other hand, if a stock is cheap in terms of its multiple for a troubling reason (or permanent deterioration of business fundamentals), such as pending depletion of oil or mineral reserves or a patent expiration, the value investor may want to shop elsewhere.
Comment:
Often the low P/E is appropriate for the stock as it is perceived to have poor potential for growth or its earnings are poor, volatile and less stable.
A low P/E does not necessarily mean higher risk, though the company should be studied with that possibility in mind.
- The low P/E stock may be selected anyway if, for example, it is a cyclical stock at a low in its cycle. Cyclical stocks - automobile manufacturers are the most notorious among them - periodically develop fire-sale P/E ratios.
- Other out-of-favour stocks also can drop to surprisingly low P/Es.
On the other hand, if a stock is cheap in terms of its multiple for a troubling reason (or permanent deterioration of business fundamentals), such as pending depletion of oil or mineral reserves or a patent expiration, the value investor may want to shop elsewhere.
Comment:
Often the low P/E is appropriate for the stock as it is perceived to have poor potential for growth or its earnings are poor, volatile and less stable.
Sunday, 25 December 2011
What do you need to beat the market? Higher mathematical expectancy
What do you need to beat the market?
You need to pick stocks of companies that have a higher mathematical expectancy than that of the market, example, the S&P 500.
Of course, this could come in many forms, for example:
- a higher earnings yield (low PE),
- better growth prospects (high EPS growth rate),
- higher certainty in the company’s future prospects (good quality business and management), or
- a cheaper stock price in relation to the business’s underlying assets (undervalued stock).
Tuesday, 13 December 2011
QUICKIES: Seven investment myths you should not fall for
Text: Prerna Katiyar | ET Bureau
Pick this stock, it's trading at 52-week low.' 'That stock is a multi-bagger, trading at such a low PE.' 'Penny stocks make fortunes while stocks trading below book value are a sure pick for making quick bucks.'
Haven't we all heard such statements at some point in our lives? If you are one of those who believe in such assertions, read on. For, these are among the many myths in investing.
Here we list seven of them
Myth No 1: Stocks trading below book value are cheap
Book value (BV) is the actual worth of a stock as in a company's books/balance sheet, or the cost of an asset minus accumulated depreciation.
BV depends more on historical cost and depreciation and often has little correlation to the current share price.
Shares of industries that are capital intensive trade at lower price/ book ratios, as they generate lower earnings. On the other hand, those business models that have more human capital will fetch higher earnings and will trade at higher price/book ratios.
"Price/book (ratio) of below 1 may be cheap but one should see other aspects such as earnings forecast, guidance, management and debt on the books of the company ," says Angel Broking's equity derivatives head Siddarth Bhamre.
Myth No 2: Stocks trading at low P/E are under-valued
Price to earning ratio (P/E) is one of the most talked about ratios in the market. This is based on the theory that stocks with low P/Es are cheap.
However, P/E alone doesn't tell much about the stock price. P/E multiples may be a quick way to value a stock but one should look at this in correlation with expected growth earnings, the risk factors involved, company's performance and growth potential .
"This is surely a myth. It is also an indication of uncertain future earning of the stock concerned," says Birla Sunlife Mutual Fund CEO A Balasubramanian.
The idea behind dividing price with earnings is to create a levelplaying field where some kind of comparison can be made between high- and low-priced stocks.
Since P/E ratios vary across sectors, with growth stocks consistently trading at higher P/E, one can only compare the P/E ratio of a stock to the average P/E ratio of stocks in that sector.
Myth No. 3: Penny stocks make good fortunes
Penny stocks by nature are lowpriced , speculative and risky because of their limited liquidity, following and disclosure.
If it's easy to invest in penny stocks - as here you shell out much less money per share than you would require for a blue-chip firm - it's also easy to lose.
Says Bhamre, "Fortune can be made by high-denomination stocks also. Denomination has nothing to do with the rationale for picking a stock. Generally , retail investors are fond of stocks that are at sub- Rs 100 levels. But there may be stocks that may be trading in Rs 1,000-plus price but may well be cheap. Clarity on earnings is more important here. Anytime, I would be more comfortable buying an ICICI Bank (currently trading at Rs 1,038) than an IFCI at Rs 45. One should look at earnings visibility."
Myth No. 4: The worst is over in the stock market
Timing the market, a common strategy among investors, means forecasting and that should best be left to astrologers and tarot readers.
If one has done one's valuation studies, one shouldn't worry about timing the market. No one had predicted the bull run would take the Sensex from a level of 10,000 in February 2006 to over 21,000 in January 2008 - just as no one had any idea of the following crash, which saw the same index plummeting to 9,000 in March 2009.
"Timing the market is more of a gut feeling. It's more on the basis of perception, as there is no such thing (that the worst is over) when the future is uncertain. One can never surely time the market. The worst is over is more of a probability than a certainty. Timing the market is very difficult as market is driven not just by earnings but also by sentiments ," says Balasubramanian.
Myth No 5: Stocks that give high dividends are the best bet
This comes from the notion that regular dividends are extra income in the shareholder's hand. This may not always be true.
While a company may be making decent payouts every year, the share price appreciation may not be comparatively high. Before investing in companies paying high dividends, it's important to analyse if the company is reinvesting enough profit to grow its earnings consistently.
Says Brics Securities' research VP Sonam Udasi: "It's not dividend that matters but the yield. For eg, a company may pay a 100% or even a 300% dividend on a stock with face value of Rs 10.
So, the investor may receive Rs 10 or Rs 30 per share when the stock may be currently trading at Rs 800 or Rs 1000. This would translate into an yield of 1% or 3% only. Also, such companies may not necessarily be reinvesting their earnings in the business to generate future earnings and so there may be no stock movement. The dividend may be high but the EPS and growth per se may be constant."
Myth N0 6: Index stocks are the best stocks
If this was true, most investors would safely park their money in such stocks in anticipation of maximum profit without looking out for other value stocks.
Most indices are a collection of stocks with the highest market cap. Take, for eg, the Sensex.
Companies that make up the index are some of the largest, with stocks that are highly traded based on their free-float.
"Index stocks may not necessarily be the best stocks as they are mostly based on market-cap or free-float of the company and not earnings. This doesn't mean that all stocks of the Sensex are highearning stocks. One must take a stock-by-stock call," says Balasubramanian of Birla Sun Life Mutual Fund.
The stock price of a company depends on its earnings. One can find high-earning stocks outside the key indices as well, he says. The risk is certainly less with index stocks as they are well researched and leaders in their respective sectors, but, again, the margins may not be very high. So it's better to keep your eyes open to other stocks, too.
Myth No 7: Stocks trading at 52-week low are cheap
Says Udasi: "There may be a time in the economic cycle when a blue-chip stock may hit a 52-week low.
But the first thing that should come to one's mind is why did the stock hit the 52-week low.
There must be something fundamentally wrong with the stock if it has hit a 52-week low, and chances are they may hit a new 52-week low.
52-week low in itself guarantees nothing. If at all one is picking stocks at 52-week lows, they should have a long-term horizon so that when the economic cycle turns, the stock is able to recover."
Needless to say, quality matters most while buying any stock.
http://economictimes.indiatimes.com/seven-investment-myths-you-should-not-fall-for/quickiearticleshow/9438662.cms
Tuesday, 11 October 2011
Buy Low - Sell High, Buy High - Sell Higher
Many investors prefer to pay low for a stock and hope that its price will eventually rise. However, they fail to realize that sometimes it is better to pay a higher price for a stock that has the potentials for a future growth. The money you will save from purchasing a down stock may not justify your investment if the stock continues to languish.
For example, let's assume that stock X has a P/E (price to earnings ratio) equal to 25, whereas stock Y has a P/E equal to 8. If you are ignorant enough and decide to make your investment decision based only on this metric, then stock X will seem as being overpriced.
Let us make another assumption, namely that stock X has experienced this overpricing for several periods of times. On the other hand, stock Y has consistently been under the fair price of the market.
What is more, stock X is experiencing a trading activity that is near the 52-week high, whereas stock Y has experienced a 20% down in its trailing 180-day average.
Typically, investors fail to recognize that the maxim stating that what goes down must come up and the vice versa, doesn't always hold truth. There are many exceptions back in the history.
If you follow this maxim, you will probably conclude that stock X is about to decrease. On the other hand, again under the maxim stated above, an investor may conclude that stock Y is about to make its big jump since its price is low and the stock market will recognize its strengths. Both assumptions may turn out to be completely wrong.
Buy High, Sell Higher
This strategy is highly recommended if you expect that the stock will continue to grow in the future. Thus, you should not be scared off by the high price. A stock that provides a steady percentage of growth is worth paying its higher price today, because if it continues to grow at this rate, its price will be even higher tomorrow.
You should make a careful research before following the Wall Street pack. You may probably regret that you haven't purchased the stock several months ago before its price has not jumped to the sky. However, if you make a careful research and verify that the stock possesses good potentials for future growth, then you should not be discouraged from investing in it.
Keep in mind that the stock's price will rise and fall in the short term, but over the long term a growth stock will move upwards.
Buy Low, Sell High
Many investors prefer to search for bargains, which they can later sell at a higher price. However, if you decide to apply this strategy you should be well aware that the price of the stock may not rise again.
Value investors tend to look for stocks that are overlooked and undervalued by the stock market. However, price is only one of the factors that are part of their selection process. The key consideration made is whether the stock provides steady potential for future growth.
Final Piece of Advice
Avoid making investment decisions based only on the price of the stock because a stock that is down is not obligatory to go up. Additionally, a stock that is up may come down and may not. Look at the other metrics in order to make a more educated and successful decision.
Friday, 25 March 2011
Price-Earning Ratio 101
What actually is PER?
It's often said that the PER is an estimate of the number of years it'll take investors to recoup their money. Unless all profits are paid out as dividends, something that rarely persists in real life, this is incorrect.
So ignore what you might read in simplistic articles and note this down: a PER is a reflection not of what you earn from a stock, but “what investors as a group are prepared to pay for the earnings of a company”.
All things being equal, the lower the PER, the better.
But the list of caveats is long and vital to understand if you're to make full use of this metric.
Last financial year, XYZ Ltd made $8 million in net profit (or earnings).
Quality has a price to match
Quality usually comes with a price to match.
It costs more, for example, to buy handcrafted leather goods from France than it does a cheap substitute from China. Stocks are no different: high quality businesses generally, and rightfully, trade on higher PERs than poorer quality businesses.
Low PER doesn't alone guarantee quality business
Avoid a Common trap: Use underlying or normalised earnings in PER
There's another trap: PERs are often calculated using reported profit, especially in newspapers or on financial websites.
But one-off events often distort headline profit numbers and therefore the PER.
Using underlying, or “normalised”, earnings in your PER calculation is likely to give a truer picture of a stock's value.
What is a normalised level of earnings?
That begs the question; what is a normal level of earnings? That's the $64 million dollar question.
If you don't know how to calculate these figures for the stocks in your portfolio, now is the time to establish whether it's skill or luck that's driving your returns. And if you don't know that, history may well make a monkey of you.
An old encounter with low PE stock: Hai-O
It is nostalgic to re-read an old post on Hai-O by ze Moola.
http://whereiszemoola.blogspot.com/2008/04/more-on-haio.html
Sunday, April 13, 2008
MORE ON HAIO
My dearest BullBear,
A low PE stock means only one thing and that is the stock is trading on a lower valuation compared to what it is currently earning.
Some simply consider that what is happening is the stock is being ignored in the market despite its impressive earnings.
Why?
The market could be wrong and that perhaps this is a stock that's an ignored gem. Yeah, the classical hidden gem and if this is the case, investors who invests in the stock could be rewarded for their stock selection.
However, on the other hand, sometimes the market could be right and that they do sense something is not right within the stock.
And because of this reasoning, I have always realised that a low PE stock does not make a stock a QUALITY stock.
It just means the stock is trading 'cheaply'.
It could be a bargain but it could also be a trap.
It's often said that the PER is an estimate of the number of years it'll take investors to recoup their money. Unless all profits are paid out as dividends, something that rarely persists in real life, this is incorrect.
So ignore what you might read in simplistic articles and note this down: a PER is a reflection not of what you earn from a stock, but “what investors as a group are prepared to pay for the earnings of a company”.
All things being equal, the lower the PER, the better.
But the list of caveats is long and vital to understand if you're to make full use of this metric.
PER: Historical versus Forward or Forecast PER
The PER compares the current price of a stock with the prior year's (historical) or the current year's (forecast) earnings per share (EPS). Usually the prior year's EPS is used, but be sure to check first.
For example:
Last financial year, XYZ Ltd made $8 million in net profit (or earnings).
The company has 1 million shares outstanding.
So it achieved earnings per share (EPS) of $8.00 ($8 million profit divided by 1 million shares).
In the current year, XYZ is expected to earn $10 million; a forecast EPS of $10.00.
- At the current share price of $100, the stock is therefore trading on a historic PER of 12.5 ($100/$8).
- Using the forecast for current year's earnings, the forward or “forecast PER” is 10 ($100/$10).
Quality has a price to match
Quality usually comes with a price to match.
It costs more, for example, to buy handcrafted leather goods from France than it does a cheap substitute from China. Stocks are no different: high quality businesses generally, and rightfully, trade on higher PERs than poorer quality businesses.
Low PER doesn't alone guarantee quality business
- Value investors love a bargain. Indeed, they're defined by this quality.
- But whilst a low PER for a quality business can indicate value, it doesn't alone guarantee it.
- Because PERs are only a shortcut for valuation, further research is mandatory.
- Likewise, a high PER doesn't ensure that a stock is expensive.
- A company with strong future earnings growth may justify a high PER, and may even be a bargain.
- A stock with temporarily depressed profits, especially if caused by a one-off event, may justifiably trade at a high PER.
- But for a poor quality business with little prospects for growth, a high PER is likely to be undeserved.
Avoid a Common trap: Use underlying or normalised earnings in PER
There's another trap: PERs are often calculated using reported profit, especially in newspapers or on financial websites.
But one-off events often distort headline profit numbers and therefore the PER.
Using underlying, or “normalised”, earnings in your PER calculation is likely to give a truer picture of a stock's value.
What is a normalised level of earnings?
That begs the question; what is a normal level of earnings? That's the $64 million dollar question.
If you don't know how to calculate these figures for the stocks in your portfolio, now is the time to establish whether it's skill or luck that's driving your returns. And if you don't know that, history may well make a monkey of you.
An old encounter with low PE stock: Hai-O
It is nostalgic to re-read an old post on Hai-O by ze Moola.
http://whereiszemoola.blogspot.com/2008/04/more-on-haio.html
Sunday, April 13, 2008
MORE ON HAIO
My dearest BullBear,
A low PE stock means only one thing and that is the stock is trading on a lower valuation compared to what it is currently earning.
Some simply consider that what is happening is the stock is being ignored in the market despite its impressive earnings.
Why?
The market could be wrong and that perhaps this is a stock that's an ignored gem. Yeah, the classical hidden gem and if this is the case, investors who invests in the stock could be rewarded for their stock selection.
However, on the other hand, sometimes the market could be right and that they do sense something is not right within the stock.
And because of this reasoning, I have always realised that a low PE stock does not make a stock a QUALITY stock.
It just means the stock is trading 'cheaply'.
It could be a bargain but it could also be a trap.
Monday, 26 July 2010
A key to beating the market is to invest in companies with strong returns on capital when they trade at low P/E's.
You wouldn't know it from looking at Acme's stock price, however. The company trades with a P/E of just 11, despite excellent returns on equity. To see the company's valuation in perspective, consider the P/E ratios of the following companies with similar returns on equity over the last five years (see chart).
Acme is not as recognizable as the rest of the names, but this is precisely why investors are offered this company at a discount. Many would argue that because the company is small, its riskiness is higher than the companies above. While that may be true to some extent (for example, three customers each exceed 10% of Acme's sales), the upside is also higher as the company has room to grow. Acme has an on-going goal of generating 30% of its sales from products developed in the last 3 years. This is something that the large companies listed above would have great difficulty achieving.
In his book, The Little Book That Beats The Market, Joel Greenblatt discusses how the key to beating the market is to invest in companies with strong returns on capital when they trade at low P/E's. Acme fits this description well.
Of course, investors cannot buy simply on the basis of a company's P/E. Further investigation of a company's risks and opportunities is necessary, as well as a careful reading of the company's notes to its financial statements.
http://www.gurufocus.com/news.php?id=86069
Saturday, 24 April 2010
A quick look at Ajiya (24.4.2010)
Ajiya Berhad Company
Business Description:
Ajiya Berhad. The Group's principal activities are manufacturing and supplying materials used in the construction and related industries. It offers metal, zinc and aluminum products for roof building, ceiling, window, and door frame and other similar products, as well as safety glass and other glass related products. Other activities include carrying on business as manufacturers, commission agents, manufacturers' agents, contractors, sub-contractor and dealers in all types of metal products and building materials, as well as providing, designing and installing metal sheet roofing and insulator materials. It also operates as an investment holding company. Operations are carried out in Malaysia and other countries.
Wright Quality Rating: LAB1
A quick look at Ajiya (24.4.2010)
http://spreadsheets.google.com/pub?key=tD3AF4z8Z_78wCEiKBcca6Q&output=html
Comment:
Profitable.
Strong balance sheet.
Low ttm-PE of 6.17, DY 2.10%
PE is low, reflecting its earnings growth potential.
Business Description:
Ajiya Berhad. The Group's principal activities are manufacturing and supplying materials used in the construction and related industries. It offers metal, zinc and aluminum products for roof building, ceiling, window, and door frame and other similar products, as well as safety glass and other glass related products. Other activities include carrying on business as manufacturers, commission agents, manufacturers' agents, contractors, sub-contractor and dealers in all types of metal products and building materials, as well as providing, designing and installing metal sheet roofing and insulator materials. It also operates as an investment holding company. Operations are carried out in Malaysia and other countries.
Wright Quality Rating: LAB1
A quick look at Ajiya (24.4.2010)
http://spreadsheets.google.com/pub?key=tD3AF4z8Z_78wCEiKBcca6Q&output=html
Comment:
Profitable.
Strong balance sheet.
Low ttm-PE of 6.17, DY 2.10%
PE is low, reflecting its earnings growth potential.
Friday, 16 April 2010
Low P/E stocks: Are they trash or are they treasure?
Some Lowest P/E Stocks
LTKM 3.02
KUMPULAN FIMA 4.06
MEASAT GLOBAL 4.54
COASTAL 5.31
AJIYA 5.40
KLCC PROP 5.76
PANTECH 5.87
DXN 6.15
POH KONG 6.22
KUMPULAN FIMA 4.06
MEASAT GLOBAL 4.54
COASTAL 5.31
AJIYA 5.40
KLCC PROP 5.76
PANTECH 5.87
DXN 6.15
POH KONG 6.22
There are reasons that stocks sink to a discount.
Low PE stocks may have:
high risk earnings or
low growth.
Nevertheless, if earnings gains keep improving, so should the P/E.
LOW P/E stocks don't just do more on the upside; they behave better when the market is falling.
Low PE stocks have little anticipation or expectation built into their price. Therefore, any improvement in performance is likely to boost the attention they get, while they suffer little if their results don't meet the Market's already low expectation.
The investor's call now is to decide
- whether these groups can stage yet another comeback, or
- whether they are on the slow train to oblivion.
- that are unfairly being beaten down because of overreaction
- from those that deserve their low prices.
The graph below depicts the KLCI index. The KLCI has risen since January 2010, lifting the prices of many stocks with it.
It should be interesting to see what have happened to these above counters since.
Wright Quality Rating: LBD8
Wright Quality Rating: LAB1
Wright Quality Rating: DBL1
Wright Quality Rating: LAA2
Wright Quality Rating: LAB1
Wright Quality Rating: CCB0
Wright Quality Rating: DANN
Wright Quality Rating: LBC0
Wright Quality Rating: LBC6
The last 3 months and 5 years charts were shown for each of the above stocks.
Looking at the last 3 months price action:
Prices trending upwards: LTKM, KFima, Measat, Coastal and Ajiya (That's not a bad bet for investors willing to wait for multiple expansion)
Prices moving sideways: KLCCP, Pantech, DXN
Prices trending downwards: Pohkong
A rising tide (market) lifts all boats (stocks). Also, there are always a lot of casualties after a bull market. Knowing that the bull market is a more dangerous period than a bear market, what can we learn, if any, from these price behaviours?
John Neff wrote, "Indifferent financial performance by low PE companies seldom exacts a penalty. Hints of improved prospects trigger fresh interest. If you buy stocks when they are out of favour and unloved, and sell them into strength when other investors recognize their merits, you'll often go home with handsome gains."
If you have any last doubts about low P/E investing, consider this:The history of low P/E investing makes it clear that you stand to make money twice.
- First, you win when companies start to earn bigger profits and share them with you by way of fatter dividends and rising share prices.
- This will wake up all those investors who've been sleeping on the sidelines. They'll start buying, the multiple will increase, and presto!--you've won again.
Related posts:
Low PE stocks may have high-risk earnings or low growth.
Low Price-Earnings Investor
Finding great values in low P/E stocks that are set to rise
Thursday, 28 January 2010
Now that the price has fallen ....
"I buy cheap stocks."
Identifying "cheap" means comparing price with value.
What attracts your attention is that the price has fallen.
Scrutinize the new lows list to find stocks that have come down in price.
If the price is at a two or three-year low, so much the better.
Some brokers may call with suggestions. These tend to be at the opposite end of the spectrum from the momentum stocks that most brokers are peddling.
Be especially attracted to stocks that have gapped down in price - stocks where the price decline has been precipitous.
Stock prices sink when investors have been disappointed, either
Identifying "cheap" means comparing price with value.
What attracts your attention is that the price has fallen.
Scrutinize the new lows list to find stocks that have come down in price.
If the price is at a two or three-year low, so much the better.
Some brokers may call with suggestions. These tend to be at the opposite end of the spectrum from the momentum stocks that most brokers are peddling.
Be especially attracted to stocks that have gapped down in price - stocks where the price decline has been precipitous.
Stock prices sink when investors have been disappointed, either
- by a recent event such as an earnings announcement below expectations, or
- by continued unsatisfactory performance that ultimately induces even patient investors to throw in the towel.
- these companies with shares that have plummeted in price, and
- in those that have slid downward gradually but persistently.
Tuesday, 26 January 2010
Some Lowest P/E Stocks
LTKM 3.02
KUMPULAN FIMA 4.06
MEASAT GLOBAL 4.54
COASTAL 5.31
AJIYA 5.40
KLCC PROP 5.76
PANTECH 5.87
DXN 6.15
POH KONG 6.22
KUMPULAN FIMA 4.06
MEASAT GLOBAL 4.54
COASTAL 5.31
AJIYA 5.40
KLCC PROP 5.76
PANTECH 5.87
DXN 6.15
POH KONG 6.22
Wednesday, 20 January 2010
Relying on a single metric misses out on the bigger picture
Too few metrics
If you focus only on a single aspect of a given company, such as its price-to-earnings ratio, you could miss out on the bigger picture. Check out the different ratings our CAPS community has assigned to stocks with similarly low P/Es:
Company
CAPS Stars (out of five)
P/E
Noble (NYSE: NE)
*****
7
Merck (NYSE: MRK)
****
10
Garmin
***
12
Qwest Communications (NYSE: Q)
**
10
Data: Motley Fool CAPS.
A closer look at these companies' other metrics would likely reveal
CAPS Stars (out of five)
P/E
*****
7
****
10
***
12
**
10
- varying debt and cash levels,
- growth rates,
- profit margins, and
- competitive advantages.
Wednesday, 9 December 2009
Low PE stocks may have high-risk earnings or low growth.
Low PE stocks may have
Assess growth and eliminate
- high-risk earnings or
- low growth.
You could modify earnings e.g.
- P/Normalised Earnings
- P/Adjusted Earnings, or
- P/Cash Earnings [=P/Cash Earnings + Depreciation + Amortisation]
- Beta or
- Debt to Equity Ratio.
- declining Earnings or
- Earnings Growth lower than the sector.
Friday, 13 November 2009
Finding great values in low P/E stocks that are set to rise
CHEAP STOCKS: ARE THEY TRASH OR ARE THEY TREASURE? A PORTFOLIO OF STOCKS SELLING FOR THE LOWEST PRICE/EARNINGS MULTIPLES WILL DO SIX TIMES BETTER THAN ONE WITH THE HIGHEST P/ES ... ... DO WE HAVE YOUR ATTENTION?
By SUSAN KUHN REPORTER ASSOCIATE KIMBERLY SEALS MCDONALD
October 16, 1995
(FORTUNE Magazine) – EVERY SO OFTEN you've got to say the heck with all those brokerage reports, newsletters, and other materials that entire forests died for. Let's face it, there are only three sure ways to beat the stock market bogey:
One: Get your investment banker brother, or some other well-placed friend, to tip you off about the next big merger;
Two: Undergo a mind meld with stock picker extraordinaire Warren Buffett; or
Three: Be a pirate, and grab a fistful of shares for way less than they're worth.
This story is not about the felonious option No. 1 or the science-fictitious No. 2. But it is a map that will lead you to the X that marks the spot where treasure often lies buried.
The X is the P/E ratio, the price of stocks relative to earnings per share, of various companies. You'll find P/Es right in the newspaper. Your task is to identify the ones that fall short of the market average--it was a recent 16.5 for Standard & Poor's 500-stock index. The signal is clear: Dig here and odds are you'll get rich. Make that very rich. Over time, say numerous studies, a portfolio of these discounted stocks will do six times better--that's right, I said six times--than a portfolio made up of shares with the highest P/E ratio. Are all you technology investors listening?
And those startling numbers are just the averages. You can improve on that performance by finding low P/E stocks that are set to rise. But which ones are they? You've got many shares to choose from in the world of low P/Es, ranging from down-and-out commodity companies to the fallen angels of tech. Some dip into discount territory for a quarter or two while others are relegated to the basement for decades on end. Your job--and the purpose of this story--is to separate the living from the dead.
Few stock groups have spent as much time in low P/E country in recent years as banks, tobacco companies, and retailers, so if you are serious about low P/E investing, you've got to make a call on these. The average major regional bank now sells at a 36% discount to the S&P 500. Tobacco companies are taking a 25% haircut. Department stores trade at an average P/E that is 18% lower than the S&P's. These three groups have spent much of the past 25 years with low P/Es, and in recent years their discounts have grown ever steeper, so their potential looms large.
Even so, as any bargain hunter with muddy boots knows, there are reasons that stocks sink to a discount. Banks, for instance, have had an unerring tendency to sabotage their balance sheets periodically with bad loans that blow up like a Scud missile. And cigarettes? Well, the short of it is that they can kill you. As for putting money into a big department store chain, why invest in an outfit that has lost so many big spenders to specialty stores?
But try to think of these well-known problems as opportunities--not only for companies to turn around but also for you to get in on the change. Still not convinced? Here's a broader perspective: Take a low P/E stock and turn the multiple upside down (that is, divide earnings per share by the stock's price). What you'll get is something called the earnings yield, which tells you how much you'll earn on your money if you buy the stock at that price. Compare this with the interest the same money would earn elsewhere, and you'll see just how bountiful these cheap stocks can be. At 16.5 times earnings, stocks in the S&P 500 earn an average 6% a year, only a very slight edge over the 5.4% paid by most money market funds and well shy of the 7% you'd get on 30-year bonds. On the other hand, regional banks sell for 10.5 times earnings, equal to a juicy earnings yield of 10%. Of course, you get only part of that 10% return mailed to you as a dividend. The rest is plowed back into the company and should boost the stock price by adding value to the company.
Buying discounted shares doesn't always end happily, but it often does. Consider the story of Nike. Beginning in the mid-Eighties, when Wall Street thought the company's days were numbered, the stock sold at six to nine times earnings, at a 50% to 70% discount to the market. From 1983 through 1990, despite some difficult years, the company managed to increase earnings fourfold as it transformed itself into a global marketing giant. This upward earnings trend continued over the next five years, and the market finally awarded the stock a higher P/E multiple. Nike shares increased 230% in value, half that gain coming from better earnings and the other half from a rise in the P/E multiple. Its shares are now trading at $92.50, 17 times earnings, a 3% premium to the market.
Nike investors who bought shares early never had any guarantees that this treasure hunt would end up the way it has, of course. Similarly, it's impossible to be certain that every bank, tobacco company, and department store will transform itself into gold. Nevertheless, if earnings gains keep improving, so should the P/E. And if those gains are as good as or better than the market's average rate of profit growth--11.8% annually over the next five years, according to a forecast by the Institutional Brokers Estimate System--then the P/E multiple should eventually be as good as or better than the overall market's. As long as these wheels are turning, the only thing you need is patience. Explains Robert Rodriguez of First Pacific Advisors in Los Angeles about this potential double-dip payoff: "If I buy a company that is cheap relative to its assets, I let the market worry, not me. If I am right about improvements, then I'll get profitability squared. Rising profits and a rising P/E multiple equals a financial home run."
This twofold kick is something pricey shares can't match. A stock like Microsoft, way out there at some 40 times earnings, must get its earnings to sprint ahead every year just to keep the stock from tumbling. Bill Gates may be able to meet this challenge, but over time the more expensive companies tend to falter. Earnings gains eventually lose speed, the P/E multiples inevitably contract, stock prices fall--and investors lose money.
The technology crowd may not wish to be reminded of this, but their chances of scoring in stocks are actually lower with the high P/E titans of tech than they are with the downtrodden shares of unloved industries. Ken French and Eugene Fama, professors at the Yale school of management and the University of Chicago, respectively, recently pounded this point home with a study of high and low P/E stocks. They measured the performance of shares on the New York Stock Exchange from July 1963 through 1993 and found that the 10% of those with the lowest P/E multiples outperformed the 10% with the highest multiples by an average of 7.6% a year. Over 30 years, every dollar invested in the low P/E group returned at least $100 more to investors--a lot of money by any account (see chart).
LOW P/E stocks don't just do more on the upside; they behave better when the market is falling. David Dreman, chairman of the Kemper-Dreman mutual fund firm in Jersey City, recently compared the total return of 1,200 stocks over a 20-year period ending in 1993 and found that when the market fell, the 20% of stocks with the lowest P/Es outperformed the 20% with the highest P/Es. The difference in quarterly losses averaged a huge 41%.
Of course, you can't make money in stocks just by citing some uplifting academic studies. Eventually you've got to put down some money, and that brings us back to the three industries mentioned above--banks, tobacco, and retailers, which have all been in the market's cellar for years. The last time that banks sold at a premium, John Kennedy was President. Once-fat premiums for tobacco companies petered out in 1953, blipped again in the 1970s, and collapsed once more in the early 1980s as health- related lawsuits scared an increasing number of Wall Streeters. Retailers have had some days in the sun over the years, but there haven't been many. From 1946 to 1953, department stores in S&P's universe, which includes May and Federated, sold at a premium to the market. From 1951 to 1963, "mail-order and general chains" like Sears Roebuck became the investor's darlings. Department stores were back in Wall Street's affections until the 1980s, when specialty stores like the Gap displaced them.
The investor's call now is to decide whether these groups can stage yet another comeback, or whether they are on the slow train to oblivion.
BANKS. Among all the low P/E stock groups, none holds as much opportunity for gains as the banks. No doubt, they are in their best shape in years. "It's banking heaven," says CS First Boston analyst Thomas Hanley. Since the dog days of 1990, when earnings and capital reserves had been pummeled to the ground after a disastrous decade of bad real estate loans and defaults on loans to Third World countries, banks have been shaping up their act. Their balance sheets look so fine that the FDIC recently voted to halve the rates banks must pay for deposit insurance. Well capitalized and healthy, many banks are looking to take some of the volatility out of their earnings by developing fee-based businesses. Selling mutual funds, for example, generates a steadier flow of profits than high-risk lending. Helping matters along, the steadily expanding economy and low inflation have been good for business.
Another trend likely to buoy the banks' P/Es: Legislation allowing interstate banking nationwide goes into effect next year, which will allow strong banks to pick up more retail customers. Even more important to investors, the wave of mergers should lead to higher stock prices in this sector as investors accord bank stocks the prices that more closely reflect their potential value as takeovers.
Sound balance sheets, a favorable economy, interstate banking, and consolidation could combine to drive bank stocks to much better valuations. "Before we are finished," says Hanley, "both money center and regional banks will be at or near a market multiple." He predicts this will happen "by the middle or end of 1996." There, in a blink, is a 36% gain in your pocket, as the discount fades away.
Make no mistake, banking as an industry is going through a take-no-prisoners sea change. Some institutions will drown and others triumph in the storm that's already raging in the erosion of interstate banking restrictions and the Glass-Steagall act, which separated the banking and securities business. The latter extends investor opportunities to brokerage firms, which Smith Barney notes carry an average discount of 16%, and to life insurers, 18%.
Clearly, winning banks will pick specialties that suit them, or a breadth of services that sets them apart from competitors--or both. In Minneapolis, for example, Norwest bank has moved smartly into new businesses but continues to lend money very well. As Larry Puglia, co-manager of the T. Rowe Price Blue Chip Growth fund, puts it, "The most important reason to own Norwest is that the credit culture is very strong there, and that's a fancy way of saying that they tend to get repaid when they lend money." (For more, see box.)
Or consider Citicorp. At $67.50, it sells for nine times earnings, a sizable 45% discount to the market. Fans include Richard Dahlberg, director of U.S. equities for Salomon Asset Management, who says, "I think there is a definite potential for financials to break out of their bands. Citicorp is a case in point. They stayed in the international area and strengthened their position in the hard times, and now that's providing an accelerating growth rate. That will be taken into consideration when you look at the multiple on the stock. That kind of company may be held in esteem instead of disrepute."
Banks may be transforming, but like Dorothy on the road to the Wiz, they're not there yet. Final destinations could turn them into one-stop financial-services centers like Charles Schwab, an outfit that offers free checking accounts and ATM cards as well as software that enables investors to use their home PCs to trade stocks, mutual funds, and money market accounts. That wouldn't be the worst fate to befall banks--at a recent $26.75 per share, Schwab commands a P/E of 33.3, or nearly three times the average bank multiple.
Investors looking for banks that might be headed for higher ground should also consider Wachovia and Mellon, which tied for first place in a "1997 cream of the crop" list put together by First Boston's Hanley. He ranked contenders on criteria such as expected return on assets, expense ratios, the mix of interest-rate-sensitive and other earnings, and dividends. Mellon, with its recent Dreyfus acquisition, has been aggressively diversifying into fee-based business, and if it can digest the purchase (see "A Bitter Lesson for Banks," August 21), its earnings may be as predictable as a clock. Wachovia, on the other hand, has stuck with its basic banking business, but the quality of its assets, tight controls on expenses, and strong generation of equity capital are exceptional. Though profits should be plentiful in the years ahead, stock prices are still cheap relative to expected earnings this year. At $45 a share, Mellon trades at 11 times 1995 earnings. At $41 a share, Wachovia carries a P/E multiple of 12.
TOBACCO. Tobacco companies could easily teach everybody a lesson or two about generating profits. For decades the industry has generated margins in the smokin' 20% range and up, vs. a 5% median for the Fortune 500. In earlier days, this meant the tobacco stocks sold at a stiff premium. Not anymore. The Food and Drug Administration's push to regulate tobacco has whacked stock prices, and so too have a host of class-action lawsuits brought by, or on behalf of, smokers who contracted lung cancer and other diseases they say were caused by smoking. The biggest threat: a class-action lawsuit named for Dianne Castano, the widow of a smoker who died of cancer. It would permit all who are or who have been addicted to nicotine, a potential horde of 80 million people, to seek damages as a group. A district court backed the suit. The industry, which wants to make every plaintiff sue individually, is appealing. With so much bad news looming, it's hard to imagine how much lower tobacco stocks could be priced. The industry had its biggest defeat in late August, when a smoker who had sued Lorillard and its filter manufacturer for an asbestos-related disease won $2 million. But the stock of Loews, Lorillard's owner, actually rose when the news hit. That could be a sign that prices for the industry have bottomed out. Says Paine Webber analyst Emanuel Goldman: "These stocks absolutely have the potential for expansion. Say the Fifth Circuit decertifies Castano. It would take 22 seconds to be reflected in higher stock prices." At a recent price of $74.75, industry leader Philip Morris trades at 12.5 times earnings, well below the S&P 500. How high could the multiple go? "If Philip Morris goes to a market multiple today, the stock goes to $110," says he. "Probably more, because it implies the external issues have been pushed to a back burner."
That kind of gain is not puffery. Neither is Philip Morris's financial picture. In the past ten years, sales and earnings have increased at a compound rate of 18.5% per year, dividends have gone up 22% on average annually, and book value has tripled. It bought General Foods in 1985; in 1988 it added Kraft. Food now accounts for over half of revenues and more than a third of operating profits, and is worth plenty. David Dreman has done a dead-or-alive analysis, assuming Philip Morris made no money on its domestic cigarette business. The 40% left was still growing at a 15% clip. If the stock price merely matches the company's annual earnings growth rate of 15% or more, investors will do nicely. Add on a 5.4% dividend, and total returns leap above 20%.
That's not a bad bet for investors willing to wait for multiple expansion. And wait they might. Tony Hitschler, a value manager with Brandywine Asset Management in Wilmington, Delaware, is not as confident as Goldman that multiples will expand right away. Says he: "With tobaccos, I believe the perceived risks and the actual risks are in line. Though the industry has been incredibly successful, the mores of our society are so much against them. I would like to see a significant price correction on bad news, which could be more liabilities, or limits on their markets." Nonetheless, even he cannot resist some of the values in the group. He's choosing RJR Nabisco, which trades at 4.6 times cash flow, half of Philip Morris's price-to-cash-flow multiple, though RJR also has more debt. The stock is now $28.38 a share. Sanford C. Bernstein, a New York City investment management company that specializes in value investing, believes Philip Morris, RJR Nabisco, Loews, and especially UST are all attractively valued, even in light of litigation and regulation risks.
RETAILERS. If you really want to go shopping for bargains, check out department store stocks. After years of watching customers leave for fancier fare, some of the best stores have finally stepped back into fashion. Says Walter Loeb, a longtime retailing-industry analyst at Morgan Stanley who now has his own firm in New York City: "Today, as I see it, there is a resurgent interest in Sears, Federated, even May. I expect there will be multiple expansion in these stocks, to a market multiple or better."
At specialty stores, the big retailers' competition, troubles are rising faster than hemlines. Sales from women's apparel have dropped dramatically, and some former star performers are losing their edge the most. Earnings at the Limited are off 11% in the first half of their fiscal year, ending in January. The Gap's profits have declined 23% compared with the same period a year ago. Their P/E multiples are also falling. The Gap's stock was selling as high as 59 times earnings in 1992. At $33 a share, the multiple is down to 16.3. The Limited's multiple peaked the same year at 32.9 times earnings and is now 15.6.
Yes, there are too many department stores fighting for the customers coming back, particularly given still-weak spending patterns. The big winners will be so-called destination stores, places that seem to hold the biggest drawing power. When you go to a mall in the future, Macy's and every other retailer around want to make sure you go there first.
Nordstrom is the rare diamond that shows what dominance can do. The Northwest-oriented retailer is consistently known for superior customer service, great-looking stores, and nice clothes, all translating to strong profits. Over the past ten years, its P/E on Merrill Lynch's earnings estimates one year out has averaged a high 32% premium relative to the S&P 500. Most department stores sell at discounts. May, for example, has a ten-year average discount of 16% relative to the market.
May, Federated, and Sears (now classified as a department store, having shed Dean Witter, Allstate, and other operations) look especially fit and in shape for investor plays. May and Federated, moreover, are themselves shopping for acquisitions. May, recently $42.50 a share and 14 times earnings, has bought a number of stores, including 13 Wanamaker outlets in Philadelphia. Federated, of course, has swallowed Macy's, and announced in August that it will buy Broadway Stores in California. Sears is increasing same-store sales faster than many of its peers. At $33.88 and just seven times earnings, it is especially cheap. "The stores look terrific and more useful, and I expect they will be more of a destination in malls again," says Loeb (for more on Sears, see Companies). Loeb is looking for the three to expand earnings 14% to 15% a year for five years, ahead of the market.
For retailers, tobacco companies, and banks, the ingredients are in place to take the stocks to a market multiple. Cheap or chancy? Make no mistake: Some companies live in the basement because that's their natural habitat. Electric utilities, for example, have sold at a discount because their profits have been largely regulated. The coming deregulation is sure to knock down shareholder value even more. As for the three stock groups we've reviewed here, well, that's a better story.
If you have any last doubts about low P/E investing, consider this: The history of low P/E investing makes it clear that you stand to make money twice. First, you win when companies start to earn bigger profits and share them with you by way of fatter dividends and rising share prices. This will wake up all those investors who've been sleeping on the sidelines. They'll start buying, the multiple will increase, and presto!--you've won again.
http://money.cnn.com/magazines/fortune/fortune_archive/1995/10/16/206857/index.htm
By SUSAN KUHN REPORTER ASSOCIATE KIMBERLY SEALS MCDONALD
October 16, 1995
(FORTUNE Magazine) – EVERY SO OFTEN you've got to say the heck with all those brokerage reports, newsletters, and other materials that entire forests died for. Let's face it, there are only three sure ways to beat the stock market bogey:
One: Get your investment banker brother, or some other well-placed friend, to tip you off about the next big merger;
Two: Undergo a mind meld with stock picker extraordinaire Warren Buffett; or
Three: Be a pirate, and grab a fistful of shares for way less than they're worth.
This story is not about the felonious option No. 1 or the science-fictitious No. 2. But it is a map that will lead you to the X that marks the spot where treasure often lies buried.
The X is the P/E ratio, the price of stocks relative to earnings per share, of various companies. You'll find P/Es right in the newspaper. Your task is to identify the ones that fall short of the market average--it was a recent 16.5 for Standard & Poor's 500-stock index. The signal is clear: Dig here and odds are you'll get rich. Make that very rich. Over time, say numerous studies, a portfolio of these discounted stocks will do six times better--that's right, I said six times--than a portfolio made up of shares with the highest P/E ratio. Are all you technology investors listening?
And those startling numbers are just the averages. You can improve on that performance by finding low P/E stocks that are set to rise. But which ones are they? You've got many shares to choose from in the world of low P/Es, ranging from down-and-out commodity companies to the fallen angels of tech. Some dip into discount territory for a quarter or two while others are relegated to the basement for decades on end. Your job--and the purpose of this story--is to separate the living from the dead.
Few stock groups have spent as much time in low P/E country in recent years as banks, tobacco companies, and retailers, so if you are serious about low P/E investing, you've got to make a call on these. The average major regional bank now sells at a 36% discount to the S&P 500. Tobacco companies are taking a 25% haircut. Department stores trade at an average P/E that is 18% lower than the S&P's. These three groups have spent much of the past 25 years with low P/Es, and in recent years their discounts have grown ever steeper, so their potential looms large.
Even so, as any bargain hunter with muddy boots knows, there are reasons that stocks sink to a discount. Banks, for instance, have had an unerring tendency to sabotage their balance sheets periodically with bad loans that blow up like a Scud missile. And cigarettes? Well, the short of it is that they can kill you. As for putting money into a big department store chain, why invest in an outfit that has lost so many big spenders to specialty stores?
But try to think of these well-known problems as opportunities--not only for companies to turn around but also for you to get in on the change. Still not convinced? Here's a broader perspective: Take a low P/E stock and turn the multiple upside down (that is, divide earnings per share by the stock's price). What you'll get is something called the earnings yield, which tells you how much you'll earn on your money if you buy the stock at that price. Compare this with the interest the same money would earn elsewhere, and you'll see just how bountiful these cheap stocks can be. At 16.5 times earnings, stocks in the S&P 500 earn an average 6% a year, only a very slight edge over the 5.4% paid by most money market funds and well shy of the 7% you'd get on 30-year bonds. On the other hand, regional banks sell for 10.5 times earnings, equal to a juicy earnings yield of 10%. Of course, you get only part of that 10% return mailed to you as a dividend. The rest is plowed back into the company and should boost the stock price by adding value to the company.
Buying discounted shares doesn't always end happily, but it often does. Consider the story of Nike. Beginning in the mid-Eighties, when Wall Street thought the company's days were numbered, the stock sold at six to nine times earnings, at a 50% to 70% discount to the market. From 1983 through 1990, despite some difficult years, the company managed to increase earnings fourfold as it transformed itself into a global marketing giant. This upward earnings trend continued over the next five years, and the market finally awarded the stock a higher P/E multiple. Nike shares increased 230% in value, half that gain coming from better earnings and the other half from a rise in the P/E multiple. Its shares are now trading at $92.50, 17 times earnings, a 3% premium to the market.
Nike investors who bought shares early never had any guarantees that this treasure hunt would end up the way it has, of course. Similarly, it's impossible to be certain that every bank, tobacco company, and department store will transform itself into gold. Nevertheless, if earnings gains keep improving, so should the P/E. And if those gains are as good as or better than the market's average rate of profit growth--11.8% annually over the next five years, according to a forecast by the Institutional Brokers Estimate System--then the P/E multiple should eventually be as good as or better than the overall market's. As long as these wheels are turning, the only thing you need is patience. Explains Robert Rodriguez of First Pacific Advisors in Los Angeles about this potential double-dip payoff: "If I buy a company that is cheap relative to its assets, I let the market worry, not me. If I am right about improvements, then I'll get profitability squared. Rising profits and a rising P/E multiple equals a financial home run."
This twofold kick is something pricey shares can't match. A stock like Microsoft, way out there at some 40 times earnings, must get its earnings to sprint ahead every year just to keep the stock from tumbling. Bill Gates may be able to meet this challenge, but over time the more expensive companies tend to falter. Earnings gains eventually lose speed, the P/E multiples inevitably contract, stock prices fall--and investors lose money.
The technology crowd may not wish to be reminded of this, but their chances of scoring in stocks are actually lower with the high P/E titans of tech than they are with the downtrodden shares of unloved industries. Ken French and Eugene Fama, professors at the Yale school of management and the University of Chicago, respectively, recently pounded this point home with a study of high and low P/E stocks. They measured the performance of shares on the New York Stock Exchange from July 1963 through 1993 and found that the 10% of those with the lowest P/E multiples outperformed the 10% with the highest multiples by an average of 7.6% a year. Over 30 years, every dollar invested in the low P/E group returned at least $100 more to investors--a lot of money by any account (see chart).
LOW P/E stocks don't just do more on the upside; they behave better when the market is falling. David Dreman, chairman of the Kemper-Dreman mutual fund firm in Jersey City, recently compared the total return of 1,200 stocks over a 20-year period ending in 1993 and found that when the market fell, the 20% of stocks with the lowest P/Es outperformed the 20% with the highest P/Es. The difference in quarterly losses averaged a huge 41%.
Of course, you can't make money in stocks just by citing some uplifting academic studies. Eventually you've got to put down some money, and that brings us back to the three industries mentioned above--banks, tobacco, and retailers, which have all been in the market's cellar for years. The last time that banks sold at a premium, John Kennedy was President. Once-fat premiums for tobacco companies petered out in 1953, blipped again in the 1970s, and collapsed once more in the early 1980s as health- related lawsuits scared an increasing number of Wall Streeters. Retailers have had some days in the sun over the years, but there haven't been many. From 1946 to 1953, department stores in S&P's universe, which includes May and Federated, sold at a premium to the market. From 1951 to 1963, "mail-order and general chains" like Sears Roebuck became the investor's darlings. Department stores were back in Wall Street's affections until the 1980s, when specialty stores like the Gap displaced them.
The investor's call now is to decide whether these groups can stage yet another comeback, or whether they are on the slow train to oblivion.
BANKS. Among all the low P/E stock groups, none holds as much opportunity for gains as the banks. No doubt, they are in their best shape in years. "It's banking heaven," says CS First Boston analyst Thomas Hanley. Since the dog days of 1990, when earnings and capital reserves had been pummeled to the ground after a disastrous decade of bad real estate loans and defaults on loans to Third World countries, banks have been shaping up their act. Their balance sheets look so fine that the FDIC recently voted to halve the rates banks must pay for deposit insurance. Well capitalized and healthy, many banks are looking to take some of the volatility out of their earnings by developing fee-based businesses. Selling mutual funds, for example, generates a steadier flow of profits than high-risk lending. Helping matters along, the steadily expanding economy and low inflation have been good for business.
Another trend likely to buoy the banks' P/Es: Legislation allowing interstate banking nationwide goes into effect next year, which will allow strong banks to pick up more retail customers. Even more important to investors, the wave of mergers should lead to higher stock prices in this sector as investors accord bank stocks the prices that more closely reflect their potential value as takeovers.
Sound balance sheets, a favorable economy, interstate banking, and consolidation could combine to drive bank stocks to much better valuations. "Before we are finished," says Hanley, "both money center and regional banks will be at or near a market multiple." He predicts this will happen "by the middle or end of 1996." There, in a blink, is a 36% gain in your pocket, as the discount fades away.
Make no mistake, banking as an industry is going through a take-no-prisoners sea change. Some institutions will drown and others triumph in the storm that's already raging in the erosion of interstate banking restrictions and the Glass-Steagall act, which separated the banking and securities business. The latter extends investor opportunities to brokerage firms, which Smith Barney notes carry an average discount of 16%, and to life insurers, 18%.
Clearly, winning banks will pick specialties that suit them, or a breadth of services that sets them apart from competitors--or both. In Minneapolis, for example, Norwest bank has moved smartly into new businesses but continues to lend money very well. As Larry Puglia, co-manager of the T. Rowe Price Blue Chip Growth fund, puts it, "The most important reason to own Norwest is that the credit culture is very strong there, and that's a fancy way of saying that they tend to get repaid when they lend money." (For more, see box.)
Or consider Citicorp. At $67.50, it sells for nine times earnings, a sizable 45% discount to the market. Fans include Richard Dahlberg, director of U.S. equities for Salomon Asset Management, who says, "I think there is a definite potential for financials to break out of their bands. Citicorp is a case in point. They stayed in the international area and strengthened their position in the hard times, and now that's providing an accelerating growth rate. That will be taken into consideration when you look at the multiple on the stock. That kind of company may be held in esteem instead of disrepute."
Banks may be transforming, but like Dorothy on the road to the Wiz, they're not there yet. Final destinations could turn them into one-stop financial-services centers like Charles Schwab, an outfit that offers free checking accounts and ATM cards as well as software that enables investors to use their home PCs to trade stocks, mutual funds, and money market accounts. That wouldn't be the worst fate to befall banks--at a recent $26.75 per share, Schwab commands a P/E of 33.3, or nearly three times the average bank multiple.
Investors looking for banks that might be headed for higher ground should also consider Wachovia and Mellon, which tied for first place in a "1997 cream of the crop" list put together by First Boston's Hanley. He ranked contenders on criteria such as expected return on assets, expense ratios, the mix of interest-rate-sensitive and other earnings, and dividends. Mellon, with its recent Dreyfus acquisition, has been aggressively diversifying into fee-based business, and if it can digest the purchase (see "A Bitter Lesson for Banks," August 21), its earnings may be as predictable as a clock. Wachovia, on the other hand, has stuck with its basic banking business, but the quality of its assets, tight controls on expenses, and strong generation of equity capital are exceptional. Though profits should be plentiful in the years ahead, stock prices are still cheap relative to expected earnings this year. At $45 a share, Mellon trades at 11 times 1995 earnings. At $41 a share, Wachovia carries a P/E multiple of 12.
TOBACCO. Tobacco companies could easily teach everybody a lesson or two about generating profits. For decades the industry has generated margins in the smokin' 20% range and up, vs. a 5% median for the Fortune 500. In earlier days, this meant the tobacco stocks sold at a stiff premium. Not anymore. The Food and Drug Administration's push to regulate tobacco has whacked stock prices, and so too have a host of class-action lawsuits brought by, or on behalf of, smokers who contracted lung cancer and other diseases they say were caused by smoking. The biggest threat: a class-action lawsuit named for Dianne Castano, the widow of a smoker who died of cancer. It would permit all who are or who have been addicted to nicotine, a potential horde of 80 million people, to seek damages as a group. A district court backed the suit. The industry, which wants to make every plaintiff sue individually, is appealing. With so much bad news looming, it's hard to imagine how much lower tobacco stocks could be priced. The industry had its biggest defeat in late August, when a smoker who had sued Lorillard and its filter manufacturer for an asbestos-related disease won $2 million. But the stock of Loews, Lorillard's owner, actually rose when the news hit. That could be a sign that prices for the industry have bottomed out. Says Paine Webber analyst Emanuel Goldman: "These stocks absolutely have the potential for expansion. Say the Fifth Circuit decertifies Castano. It would take 22 seconds to be reflected in higher stock prices." At a recent price of $74.75, industry leader Philip Morris trades at 12.5 times earnings, well below the S&P 500. How high could the multiple go? "If Philip Morris goes to a market multiple today, the stock goes to $110," says he. "Probably more, because it implies the external issues have been pushed to a back burner."
That kind of gain is not puffery. Neither is Philip Morris's financial picture. In the past ten years, sales and earnings have increased at a compound rate of 18.5% per year, dividends have gone up 22% on average annually, and book value has tripled. It bought General Foods in 1985; in 1988 it added Kraft. Food now accounts for over half of revenues and more than a third of operating profits, and is worth plenty. David Dreman has done a dead-or-alive analysis, assuming Philip Morris made no money on its domestic cigarette business. The 40% left was still growing at a 15% clip. If the stock price merely matches the company's annual earnings growth rate of 15% or more, investors will do nicely. Add on a 5.4% dividend, and total returns leap above 20%.
That's not a bad bet for investors willing to wait for multiple expansion. And wait they might. Tony Hitschler, a value manager with Brandywine Asset Management in Wilmington, Delaware, is not as confident as Goldman that multiples will expand right away. Says he: "With tobaccos, I believe the perceived risks and the actual risks are in line. Though the industry has been incredibly successful, the mores of our society are so much against them. I would like to see a significant price correction on bad news, which could be more liabilities, or limits on their markets." Nonetheless, even he cannot resist some of the values in the group. He's choosing RJR Nabisco, which trades at 4.6 times cash flow, half of Philip Morris's price-to-cash-flow multiple, though RJR also has more debt. The stock is now $28.38 a share. Sanford C. Bernstein, a New York City investment management company that specializes in value investing, believes Philip Morris, RJR Nabisco, Loews, and especially UST are all attractively valued, even in light of litigation and regulation risks.
RETAILERS. If you really want to go shopping for bargains, check out department store stocks. After years of watching customers leave for fancier fare, some of the best stores have finally stepped back into fashion. Says Walter Loeb, a longtime retailing-industry analyst at Morgan Stanley who now has his own firm in New York City: "Today, as I see it, there is a resurgent interest in Sears, Federated, even May. I expect there will be multiple expansion in these stocks, to a market multiple or better."
At specialty stores, the big retailers' competition, troubles are rising faster than hemlines. Sales from women's apparel have dropped dramatically, and some former star performers are losing their edge the most. Earnings at the Limited are off 11% in the first half of their fiscal year, ending in January. The Gap's profits have declined 23% compared with the same period a year ago. Their P/E multiples are also falling. The Gap's stock was selling as high as 59 times earnings in 1992. At $33 a share, the multiple is down to 16.3. The Limited's multiple peaked the same year at 32.9 times earnings and is now 15.6.
Yes, there are too many department stores fighting for the customers coming back, particularly given still-weak spending patterns. The big winners will be so-called destination stores, places that seem to hold the biggest drawing power. When you go to a mall in the future, Macy's and every other retailer around want to make sure you go there first.
Nordstrom is the rare diamond that shows what dominance can do. The Northwest-oriented retailer is consistently known for superior customer service, great-looking stores, and nice clothes, all translating to strong profits. Over the past ten years, its P/E on Merrill Lynch's earnings estimates one year out has averaged a high 32% premium relative to the S&P 500. Most department stores sell at discounts. May, for example, has a ten-year average discount of 16% relative to the market.
May, Federated, and Sears (now classified as a department store, having shed Dean Witter, Allstate, and other operations) look especially fit and in shape for investor plays. May and Federated, moreover, are themselves shopping for acquisitions. May, recently $42.50 a share and 14 times earnings, has bought a number of stores, including 13 Wanamaker outlets in Philadelphia. Federated, of course, has swallowed Macy's, and announced in August that it will buy Broadway Stores in California. Sears is increasing same-store sales faster than many of its peers. At $33.88 and just seven times earnings, it is especially cheap. "The stores look terrific and more useful, and I expect they will be more of a destination in malls again," says Loeb (for more on Sears, see Companies). Loeb is looking for the three to expand earnings 14% to 15% a year for five years, ahead of the market.
For retailers, tobacco companies, and banks, the ingredients are in place to take the stocks to a market multiple. Cheap or chancy? Make no mistake: Some companies live in the basement because that's their natural habitat. Electric utilities, for example, have sold at a discount because their profits have been largely regulated. The coming deregulation is sure to knock down shareholder value even more. As for the three stock groups we've reviewed here, well, that's a better story.
If you have any last doubts about low P/E investing, consider this: The history of low P/E investing makes it clear that you stand to make money twice. First, you win when companies start to earn bigger profits and share them with you by way of fatter dividends and rising share prices. This will wake up all those investors who've been sleeping on the sidelines. They'll start buying, the multiple will increase, and presto!--you've won again.
http://money.cnn.com/magazines/fortune/fortune_archive/1995/10/16/206857/index.htm
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