Identifying the lowest prices doesn't always mean finding the best bargains, but it sure is a good place to start.
Today, we'll do just that by looking at the 10 cheapest stocks in the S&P 500.
For those unfamiliar with it, the S&P 500 (INDEX: ^GSPC ) includes 500 of the biggest public companies in the U.S. stock market. It pretty much encompasses all the names you can think of -- Apple, Coca-Cola, IBM, P&G, ExxonMobil, Bank of America, Verizon, FedEx, McDonald's, Johnson & Johnson, Wal-Mart, and Amazon.com, to name a few. It captures around three-quarters of the value of the entire U.S. stock market and includes most of the leading companies with market caps above $1 billion. ExxonMobil's leads the list at $375 billion.
You may be surprised that none of the names I've mentioned so far make today's list of the 10 cheapest big-time stocks.
The 10 cheapest stocks
The usual basic metric for "cheapness" is the P/E ratio, which looks at a stock's price versus one year's worth of past performance.
I prefer a longer time period, so I like using a five-year P/E ratio. In other words, I take today's price and divide it by the five-year average of annual earnings. Five years balances the need to include good years and bad with the need to include timely data.
To put the numbers you're about to see in perspective, a regular one-year P/E ratio of less than 15 is pretty attractive. One less than 10 gets me very interested. So when we see five-year P/E ratios of less than 10, it's definitely worth looking further.
Here, then, are the 10 lowest five-year P/E ratios in the S&P 500.
5-Year P/E Ratio
|MEMC (NYSE: WFR )
||Semiconductors Including Solar
|Hewlett-Packard (NYSE: HPQ )
||Property and Casualty Insurance
|Western Digital (NYSE: WDC )
||Tech (Data Storage)
|Corning (NYSE: GLW )
||Specialty Glass and Ceramics
|L-3 Communications (NYSE: LLL )
||Offshore Oil and Gas Drilling
Source: S&P Capital IQ. Excludes companies with significant discontinued operations and/or fiscal-year changes.
When you're scanning a list of beaten-down stocks, you'll find that the market has reasons for its fears:
- MEMC's profitability on its silicon wafers has plummeted from fiercely positive in 2007 to a loss in the past 12 months as supply and demand in the solar and tech industries have rocked it.
- HP and Western Digital face the specter of all tech companies: obsolescence.
- NRG Energy's latest 12-month profitability is less than half of its five-year average. Although NRG has clean-energy street cred, the earnings volatility and lack of dividend aren't ideal for traditional utility investors.
- Assurant, Travelers, and WellPoint all face balance-sheet scrutiny in a post-AIG-blowup world, and Assurant and Wellpoint face the uncertainty of future health-insurance regulations.
- Corning faces both potential lower demand for its specialty glass in the LCD TV market and margin compression.
- L-3, like all U.S.-based defense contractors, lives at the mercy of future U.S. government defense budgets, which are currently facing Congressional pressure.
- Diamond Offshore is an offshore oil and gas driller. Post-BP's 2010 Gulf oil spill, the drillers have had regulatory concerns priced in.
So we have the classic bargain hunter's conundrum in front of us. We see very cheap prices but very real risks. On balance, though, I see a lot of opportunity in these 10 names.
For example, three of the stocks have better recent earnings than their five-year averages: HP, Corning, and L-3. In other words, despite fears over their futures, their recent operational performance tells a different tale.
- HP is the cheapest stock of the 30 Dow Jones (INDEX: ^DJI ) companies. I worry about moves like its expensive Autonomy purchase, but if new management under Meg Whitman impresses me, I could see eventually buying in.
- Corning shares have jumped up a bit since I wrote that it was a "buy" back in October, but I like its prospects at current prices as well.
- L-3 is among a basket of defense stocks I own. I can't predict the vagaries of Washington's power dynamics and future world events, but I'm comfortable buying a bunch of cheaply trading companies in an industry the government needs to keep alive for national security reasons.
The bottom line
I highlighted HP, Corning, and L-3 because of their recent earnings strength, but digging further into each of the 10 cheapest companies in the market can reap rewards as well.
Of course, going into the bargain bin isn't for everyone. It's tough work, and there's much uncertainty in the futures of these 10 stocks. Fortunately, there are easier routes, like buying into solid, dividend-paying blue chips at good prices. On that note, we recently finished writing an excellent new 11-stock free report that includes "5 All-Around Dividend Rock Stars." You can file those stocks in the easy bucket. I invite you to grab a free copy.