When it comes to price-to-earnings (P/E) ratios, the notion of
"buy low and sell-high" doesn't always apply. Some stocks with the
lowest P/Es are cheap for good reason. Perhaps they are in the
midst of a long-term decline that will see sales and profits
shrink. Or perhaps they are simply out-of-favor at the moment, and
will be snapped up by investors (and garner a higher P/E) once
operations are on the upswing.
We ran a screen of all the stocks in the S&P 500 and came up
with a short list of the companies that have a
ratio below 10. Each has entered the dog house for their own
company-specific reasons. What will it take to get then our of the
Eastman Kodak (
This venerable photography equipment firm has seen its obituary
written before, though many are betting its days may still be
numbered. Shares trade for just nine times trailing profits, simply
because investors believe future profits will shrink or even turn
to losses. This is a real case of the Bears vs. Bulls.
Bearish investors predict that the core film developing
business, which has shrunken considerably but still throws off
, will eventually dry up. (Though some believe the legacy business
may have found a floor, supporting demand for printing press
plates, color negative paper and other old-school photography
hardware). The company has bought time by re-financing its debt
burden but will eventually need to start paying off its more than
$2 billion in debt.
Bullish investors can cite a host of positives. For example, few
would have guessed a few years ago that Eastman Kodak would
re-emerge as a rising vendor of digital cameras. The company has
in this area for three straight years, though it still lags the
market share rates of the biggest players. In addition, Kodak chose
to take the high road in the ink-jet printer market, charging
higher prices for a line of printers that pack more features than
basic ink-jet printers. Right now, cash flow generated from these
two newer businesses roughly offset the decline in the legacy film
The wildcard in the mix -- and a possible game changer -- is the
company's strong base of patents. Earlier this year, Samsung cut
Eastman Kodak a check for $550 million after it was found that
patents were violated. The United States International
Trade Commission is still expected to weigh in on some
patent contentions, so any future royalty payments from firms like
Apple (Nasdaq: AAPL) and Research in Motion (Nasdaq: RIMM) are
unlikely to materialize until 2011 -- if at all. But royalty income
is notoriously erratic, so most investors ignore it when
calculating earnings estimates or P/E ratios. Most investors think
Kodak will lose a small amount in 2011 -- unless it can secure more
Notably, Kodak is valued at a very low rate relative to its
sales base. Sure annual sales have shrunk from $10 billion in 2007
to the current $7.0-$7.5 billion range, but the company's
(market value minus cash plus debt) is just $2.3 billion, implying
an EV/sales ratio of just 0.3. That's absurdly low for a tech
company, even more absurd that a P/E ratio of nine.
Action to Take --> Eastman Kodak is going to either get real
traction on its new sexier business lines or will find itself being
chased by suitors for the value of its still-strong revenue base. A
larger tech firm can surely find a way to squeeze more profits out
of the $7 billion revenue base. In this instance, the low P/E ratio
is alerting investors to a real bargain.
We recently looked at the deep troubles of major grocery chains,
though we also concluded that SUPERVALU is likely most immune from
further share price weakness, especially since it has the lowest
P/E ratio in the S&P 500. While shares are super-cheap,
management is applying cash flow to share buybacks and if that
process continues, per share profits could start rising at a +10%
to +12 % clip.
Action to Take --> This is surely a deep-value situation.
Investor patience is required but investors are simply too bearish
on a fairly bleak situation.
Some stocks deserve a low P/E if their sales and profits are likely
to keep falling. That appears to be the case for GameStop. For
starters, video game makers are tired of seeing their customers
spend money on used games at places like GameStop, as they derive
zero revenue from those re-sales. So they have begun to release
periodic online updates of hot games, in hopes of securing more
revenue from each title and discouraging consumers from trading
them in for other titles. The trend is already underway in China,
and is just getting started here in the United States.
In addition, a 10,000 pound gorilla just walked into the
neighborhood. Best Buy (
) has announced plans to enter the market for used video games. You
can bet they'll aggressively price used gaming titles to quickly
steal customers away from GameStop. GameStop has few options but to
play the price war game.
Analysts see the company boosting sales another +5% this year,
but forecasts of further growth in 2011 appear increasingly
unlikely even though analysts still assume GameStop can keep
growing. They appear to be ignoring those above-cited factors.
That's why shares trade for less than 10 times trailing profits and
around seven times consensus fiscal (January) 2012 profits. Few
believe the consensus figure will be reached, otherwise shares
would be well higher.
Action to Take --> Wait for some positive news that pushes
shares back into the $20s. The company may announce a solid quarter
or benefit from a fresh market rally. This would then set up a
great trade -- on the short side.
Dean Foods (
In a similar vein, Dean Foods' low P/E multiple shouldn't entice
investors. Pricing pressures are forcing profit margins down to
historical lows for this supplier of dairy products to supermarket
chains. We added that the company's high debt levels means massive
interest costs, which saps many of the profits the company would
hope to keep.
Action to Take --> In early May, we predicted that shares had
further to fall. They've actually risen +10% since then, but still
look headed for further weakness.
A low P/E ratio does not ensure that a stock will rise, but when
paired with a very low price-to-book value ratio, it tells you that
shares are being overly discounted. Assurant, which provides
insurance policies in niche areas like disability, funeral care
expense and after-warranty protection for aging cars, trades for
just eight times trailing profits and around 80% of
Assurant has taken its shares of lumps. The company was heavily
exposed to the housing crisis as it offered debt and credit
protection to consumers, only to end up making big payouts. But
that trend has abated and results are on the upswing. Profits have
rebounded, bringing in more cash for the
and pushing tangible book value ever-higher to a recent $43 a
Action to Take --> Assuming shares simply rise up to book
value, then investors are looking at a +20% gain. Looking at it
another way, if shares trade up to a forward P/E of 10, then shares
would reach about $48 -- more than +30% above current levels.