Over the last two decades, value investors have only been able to read stories of a time, in the 1970s, when large numbers of stocks were trading with price-to-earnings (P/E) ratios of 10 and under. Since the 1970s, a P/E ratio this low would either represent an extreme value stock or that there was something negative going on with the company. Occasionally, over the years, investors would find some companies at this extreme value level. The decline in the markets in 2008 appears to be, once again, providing investors with an opportunity to buy stocks at extremely cheap valuations.
In fact, running a basic screen on the custom screener for a Zacks Rank of 1-3 and a P/E under 5.0 brings up over 300 stocks.
Not all of these companies are investor-worthy. Some are penny stocks or are micro-caps. But even if you screen out for company size and/or market cap, there are still nearly 200 companies to choose from.
An Embarrassment of Riches or a Value Trap?
The problem with only looking at a P/E is that the "E" part has to be correct. In this economic environment, where companies are warning about the quarter or the year nearly every day, how accurate are the earnings estimates or the guidance projections?
There are some analysts who answer "not very." So a company that is trading at only 5 times forward earnings may not be "cheap" as estimates fall. The current P/E is a red herring because no one knows what future earnings are likely to be. This dilemma has become apparent in recent weeks as some companies have warned on estimates.
Gardner Denver Inc. (GDI), for example, which manufactures compressors and pumps for the industrial and transportation sectors, recently announced that its European and American sales slowed significantly during the quarter. The company cut estimates for the fourth quarter to the range of 48 to 52 cents from previous guidance of 77 to 83 cents. For the full year, forecasts were slashed to $3.00 to $3.04 from $3.29 to $3.35.
Gardner Denver, a Zacks #3 rank stock, had been trading with a forward P/E of 6.38 but if the company comes in at the lower end of its full-year guidance it will be trading at 7.7x forward earnings. Using 2009 estimates, which have declined from $4.14 to $2.82 in the last 90 days, the P/E jumps to 8.14.
Keep an Eye on Upcoming Earnings
The following are six companies in various sectors that are all trading under 8x forward earnings. They appear to be cheap but consensus estimates continue to be revised. A company trading at 5 times forward earnings could easily soon be trading at 10 times forward earnings once estimates are revised to reflect the slowing economy.
Tracey Ryniec is a Value Analyst at Zacks Investment Research covering Value stocks. She also contributes to the Zacks Elite website to Timely Buy of the Week. For more information please visit www.zacks.com
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