4 Ways to View PE Ratios

11/24/2014 9:00 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

Among valuation variables, the price/earnings ratio is hands down the most popular. Still, no single variable works best all of the time, suggests Richard Moroney, editor of Upside Stocks.

Moreover, taking a broader view of valuation can help you uncover bargains that the standard P/E-based screens will overlook.

With that in mind, we screened for bargain-priced stocks, looking beyond the traditional P/E to highlight some bona fide values.
Cash-adjusted P/E
A sizable net cash position, the amount by which cash exceeds total debt, can distort valuations. Cash-adjusted P/E shows how much you are paying for a company’s operating businesses.
Consider CRA International (CRAI), a global consulting firm, which has about $4.50 in cash per share on its balance sheet, or nearly 15% of its stock price.

Subtracting cash from the stock price and dividing by trailing earnings puts the cash-adjusted P/E at 19, below the traditional P/E of 22.

Historical P/E

Without some historical perspective, P/E has limited value. We always like to compare P/Es with average and median ratios for prior years if a company has not undergone a major change. One useful screen looks for stocks with forward P/Es below five- and ten-year norms.

Midsouth Bancorp (MSL) earns a Value score of 92 and looks unduly cheap. At 12 times estimated current-year earnings, shares trade at discounts of 34% to the five-year average forward P/E and 33% to the ten-year norm.

Relative P/E

Standout value plays typically look cheap compared to industry and sector peers. Even after surging 27% on strong quarterly results, Sanmina (SANM) looks undervalued from several angles.

At 12-times trailing earnings, the stock trades well below the average of 21 and median of 19 for S&P 1500 technology stocks. The stock also looks cheap compared to electronic-manufacturing stocks, which trade at an average P/E of 17.

PEG ratio

The ratio divides a stock’s current-year P/E by the expected long-term growth rate for earnings per share. The real power of PEG is its ability to uncover stocks for which growth expectations are modest and capable of turning higher, triggering a revaluation.

Over the next five years, consensus estimates project, ON Semiconductor (ONNN) will increase per-profits by 24% annually. The current-year P/E is 10, putting the PEG at 0.4, lower than about 97% of stocks in our research universe.

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