Stocks that are cheap aren't necessarily great buys. Often, a low price-to-earnings (P/E) ratio means that the market is expecting earnings to decline going forward.
The market isn't always right, though, and on some occasions, pessimism gets out of hand. Here are three stocks that bargain-hunting investors should have on their radars. All of them come with risks, but extremely low valuations make each an interesting investment opportunity.
PCs and printers
Following the split of the old Hewlett-Packard into two companies, HP Inc. (NYSE:HPQ) is focused primarily on PCs and printers. Neither is a particularly attractive business at the moment, with both segments suffering steep declines in revenue during HP's latest quarter. But the company still generates plenty of profits, and through both dividends and share buybacks, it returns much of those profits to investors.
HP is the second-largest PC manufacturer in the world and it leads the global printer market, responsible for 20% of printer sales last year. The company generates most of its profits from its printing segment, which still enjoys operating margins in the high teens. The PC business generates narrower margins, but the industry continues to consolidate around a handful of major players -- HP being one of them.
HP expects to generate between $1.59 and $1.65 in per-share non-GAAP EPS during fiscal 2016, putting the current stock price at just 8.6 times the midpoint of that range. That low price, combined with a dividend yield of 3.5% and heavy share buybacks, makes HP an interesting investment. The stock would be a bargain if HP could maintain its current level of earnings, but with both of its core businesses in decline, there's no guarantee that it can.
For investors, the risk that HP's earnings may suffer a prolonged slump adds risk, and makes the stock less cheap than it otherwise appears. But if HP can manage to maintain its earnings, as analysts expect it to do next year, that single-digit P/E ratio starts to look enticing.
Cars and trucks
Carmaker General Motors (NYSE:GM) is another stock trading at a single-digit multiple of earnings. But unlike HP, GM is firing on all cylinders. The company's profits are soaring, driven by strong demand in the U.S., and GM's post-bankruptcy efforts to become a leaner company. During the second quarter, revenue climbed 11% year over year, while adjusted operating income rose 37%. GM expects to generate as much as $6 per share in adjusted profits this year, putting its P/E ratio at a measly 5.3.
The automotive industry is cyclical, and GM's profits will fluctuate based on demand. With U.S. automotive sales fully recovered from the financial crisis, the fear of a downturn in sales has investors avoiding GM stock. The memory of the government's bailout of the old GM is still fresh in investors' minds, and the company has yet to prove that it can be profitable in a difficult demand environment.
The good news is that GM is a more efficient company than it was a decade ago. According to CEO Mary Barra, total U.S. automobile sales would need to fall below 10 million to 11 million annually before GM's U.S. operation would start posting losses. That would represent a steep decline from the 17.5 million automobiles sold during 2015. A downturn like that is possible, but GM is in much better shape to handle it.
GM's earnings could peak this year, and investors are right to be concerned that the current level of profitability won't last forever. But with the stock trading for a minuscule multiple of earnings, GM's shares look like a steal.
Bed and bath... and beyond
Retail has always been a tough business and it's not getting any easier with online retailers like Amazon changing how consumers make purchases. Many retailers are struggling with weak traffic and slumping sales, including Bed Bath & Beyond (NASDAQ:BBBY). During the first quarter, the company reported a 0.5% decline in same-store sales and an 22% slump in net income. The stock has tumbled 42% since the start of 2015, driven down by a string of lackluster results.
Despite its troubles, Bed Bath & Beyond is still profitable. The company expects to generate between $4.50 and $5.00 in per-share earnings this year, putting the stock price at just 9.2 times the midpoint of this range. Margins have taken a hit, but extensive share buybacks are helping to soften the blow on a per-share basis.
Bed Bath & Beyond is growing its e-commerce business, with sales from digital channels up more than 20% during the first quarter. The entire retail industry is adjusting to the continued growth of e-commerce, and Bed Bath & Beyond is no exception.
Bed Bath & Beyond's success in the past doesn't guarantee that it will be successful in the future. But with the stock beaten down over the past 18 months, bargain hunters should be on alert.