Even using it as shorthand for value, the price-to-earnings (P/E) ratio has its limitations, but the widely used indicator does give investors at least an at-a-glance measure for whether a stock might be under-, fairly , or overvalued. Calculated by dividing a company's stock price by its trailing earnings per share, another variant can be used to look ahead at future value by dividing the price by analyst estimates of forecast earnings for the coming year.
In both instance, many investors mistakenly never go any further in their stock analysis than either of these calculations. We're using the tool here only as a jumping-off point to narrow our universe of stocks.
Let's take a look at Bed Bath & Beyond (BBBY), Ford (F -0.41%), and Goodyear Tire & Rubber (GT -1.72%). All of these stocks have forward P/E ratios below 10, or less than half the current valuation of the S&P 500. This makes them among the most heavily discounted stocks in the broad market index. Here's why this may be the case.
Image source: Bed Bath & Beyond.
Bed Bath & Beyond (forward P/E: 9.1)
Beset by customers who have moved away from shopping at brick-and-mortar stores in favor of online retailers, Bed Bath & Beyond was at first slow to realize the threat and has since been trying to make up for lost time. That has resulted in some acquisitions of dubious value, such as the purchase of flash-sale site One Kings Lane and personalized gift site PersonalizationMall.com.
Though not particularly expensive purchases for the retailer -- and in fact, it got the flash-sale site for a heavily marked-down price -- they're also not going to fix what ails Bed Bath & Beyond nor move the needle in sales. It's facing continued declines in customer traffic and its profit margins have been hit by its own prodigious couponing efforts, let alone the promotional environment in which all retailers are operating.
There might not be much Bed Bath & Beyond can do about it at the moment, other than make a transformational acquisition, which doesn't appear likely. It does, however, keep fiddling around the edges, adding more concepts onto an amalgam of assorted retail brands. It's not resonating particularly well with consumers, though.
Beyond just its cheap trailing and forward P/E ratios, the company is discounted significantly across many metrics, including a price to free cash flow of just 7, which puts it in the bargain-basement bin. Bed Bath & Beyond does still generate a lot of cash, and it just started paying a dividend to return value to its shareholders, but there doesn't seem much on the horizon right now to recommend this stock. It looks cheap -- and it is cheap -- because there are little to no catalysts for growth.
Image source: Ford.
Ford (forward P/E: 7.4)
Automakers set another sales record last year, producing 17.55 million vehicles, beating its previous record year 2015, which featured 17.5 million vehicles made. It was, in fact, the seventh straight year of rising car sales, but importantly for Ford, they've also been buying trucks.
The F-series pickup truck remains the best-selling vehicle on the market by a wide margin. That standard continued into 2017 with the F-series truck selling almost 58,000 units in January, up 12.5% from last year and 63% more than the second-place Chevy Silverado that sold over 35,500 trucks. In February, they jumped another 9% to 66,000 units, their best showing since 2004.
So why is Ford being marked down? Analysts don't see the record-setting growth continuing this year. They note car manufacturers have relied heavily on discounts and promotions to draw in buyers, though Ford has said its own average retail price was $2,500 higher in January and up $1,900 in February Also the banner sales years the automakers recorded have taken up much of the excess slack in demand from the market. When you've only recently bought a new vehicle, there's no reason to go out and buy another. Ford's overall sales last month fell 4%, despite the strength in its trucks and SUVs and the market may be lumping it in with the broader industry trends and expecting some of the lift it's enjoyed to evaporate. Car sales, after all, were down 24% year over year.
So while 2017 may not surpass the sales set last year, analysts do still see industry sales remaining above 17 million vehicles, which is a robust market at any time, which may mean Ford will surprise Wall Street and make its current stock price a bargain.
Image source: Goodyear Tire & Rubber.
Goodyear Tire (forward P/E: 7.1)
Certainly, tire maker Goodyear is seemingly inextricably tied to the trends facing the auto industry, but its business in the Americas, its largest market, has been hurt by an oversupply of heavy-duty trucks. While tire sales in the latest quarter fell in every region it services, none was worse than the Americas, where revenues tumbled nearly 11%. to $2.1 billion. But after swinging to a profit of $561 million from a year-ago loss of $380 million, Goodyear's stock popped 12% for the month of February and is up 22% over the last six months.
Stocks coming off losing years can look cheap, however. Analysts are only looking for the company to grow earnings over the next five years at a paltry 6.5% compounded rate, suggesting the market's valuation is being masked by previously muted results and a low bar set by Wall Street. But tires aren't exactly a sexy, high-growth business so Goodyear typically gets heavily discounted by the market anyway.
Because Goodyear also says it anticipates rising raw material cost headwinds in 2017, it suggests the gains its stock has made might be as good as it gets for awhile.
