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Many value investors focus on finding stocks that are as cheap as possible, counting on a return to more normal conditions returning earnings multiples to higher levels. Yet even though it doesn't take much to find stocks with low price to earnings ratios, figuring out whether they're actually smart buys takes a little more work.
Below, we'll show you the 10 stocks that currently have the lowest forward earnings multiples, and then take a closer look at which companies have the best prospects going forward.
The top 10 lowest P/Es in the stock market
Here are the 10 stocks in the S&P 500 with the lowest forward P/E ratios as of July 8:
Data source: Yahoo! Finance.
The first thing to realize in looking at this list is that in some cases, company-specific challenges are responsible for low earnings multiples, and what looks like an obvious bargain actually includes plenty of uncertainty. Endo International is a good example, because the pharmaceutical company has posted huge losses for four straight years. Even in its most recent financial report, Endo said GAAP earnings for the year could come in as low as $0.25 to $0.55 per share. However, many sources measure forward earnings based on adjusted figures, and Endo thinks it will bring in $4.50 to $4.80 per share in adjusted earnings for the year. With Endo having seen huge asset writedowns, goodwill impairment charges, legal settlements, and losses from discontinued operations over the past several years, many would argue that it's unfair to ignore all of those items in favor of using adjusted figures that paint a rosier picture of Endo.
Image source: Ford.
Beyond company-specific issues, the list makes it clear that some industries are facing challenges that span many companies. The auto industry had a record sales year in 2015 as U.S. consumers jumped back into buying mode. Low gasoline prices that drivers hadn't seen in years helped support purchases of larger vehicles like trucks and sport-utility vehicles, which are among the most profitable for companies like Ford and General Motors. Yet part of the reason for the low earnings multiples for General Motors and Ford is that few expect the auto industry to be able to sustain its recent success. Automakers are cyclical, and huge sales one year can point to weaker results in future years. If fuel prices start to recover from their plunge in 2015, then it could be another headwind that hurts automaker stocks.
Similarly, the airline industry has had unprecedented success in generating profits, with Delta, American, and United Continental all using baggage fees and other ancillary charges to help boost their bottom lines. Consolidation in the industry has also reduced competition and made it easier for airlines to maintain their fare pricing discipline. Yet most of the concern surrounding airline stocks centers on declines in unit revenue. Some of the difficulties have come from ultra-low-cost carriers that have captured cost-sensitive travelers and eaten into potential profits at major airlines like Delta, American, and United Continental. Future rises in fuel costs could also reverse some profits. Yet if the airlines remain smart about keeping capacity under control, they'll face a much better chance of weathering any future storms.
Is there real value here?
One thing to consider in making value-based investments is what would happen if your investment thesis is wrong. With Ford and General Motors sporting forward P/Es of between 5 and 6, even if their earnings unexpectedly get cut in half at some future point, multiples of 10 to 12 would still be reasonably attractive. Both GM and Ford also pay strong dividends, and that can help shareholders get through tough times as well.
Image source: Delta Air Lines.
Airlines with forward earnings multiples in the 6 to 7 range are in a similar position, with even a 50% miscalculation producing true P/Es of 12 to 14. For airlines, the big question is whether serious competition will start to emerge and have a serious impact on potential future growth. In the past, boom times for profits have usually resulted in new airlines seeking to cash in on opportunities to make money, and the resulting fare wars have been a major reason so many airlines have had to go through bankruptcy proceedings at least once in their histories. To avoid that fate, airlines will have to be a lot smarter in how they manage their fleets and keep a close eye on their peers.
Stocks with low P/Es are attractive for value investors, but you can't just buy them all without looking at the conditions each faces. Only by understanding why a company's earnings multiple is so low will you avoid buying into value traps and instead find the best opportunities in the market.
The article These Are the 10 Lowest P/E Stocks -- but Are Any True Bargains? originally appeared on Fool.com.
Dan Caplinger owns shares of Ford. The Motley Fool owns shares of and recommends Ford. The Motley Fool recommends General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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