Everyone loves a good cheap stock, and stocks trading for a P/E of 10 or so seem "good and cheap." But which cheap stocks are the best ones to buy?
I recently ran a screen seeking brand-name stocks selling for about 10 times earnings or below, and projected to grow earnings at better than 10% annually over the next five years. That fits the textbook definition of a "value stock" with a PEG ratio of less than 1.0. You might think it would be hard to find such bargains in a stock market as overheated as ours is. But in fact, I came up with a good handful of intriguing ideas.
Here are three of them.
American Outdoor Brands
I'll say right out that this is my favorite of the three low P/E stock ideas that came out of this month's screening exercise. American Outdoor Brands (SWBI -2.58%) -- the gunsmith formerly known as Smith & Wesson -- saw its stock rocked last week after reporting its fiscal fourth-quarter 2017 earnings.
American Outdoor easily topped both sales and profits expectations for the quarter, but for investors, what American Outdoor did didn't matter so much as what it promised to do going forward. Namely, American Outdoor warned that profits in fiscal Q1 2018 could fall as low as just one penny a share, and profits for this full fiscal year will likely range between $1.16 and $1.26 per share -- far below analyst estimates, and about 44% less than what the company earned last year.
Investors promptly panicked and sold off the stock, which, at a recent price below $22 per share, is selling for less than 9 times earnings. But here's the thing: Despite near-term weakness in sales and earnings, analysts still see a bright future for American Outdoor Brands, and they predict the stock will turn around and grow earnings at about 15% annually over the next five years. That works out to a PEG ratio of just 0.6 on this classic American stock. I'd buy it before the summer is out, while the stock remains a red-hot bargain.
You've probably been reading a lot about the U.S. steel industry lately, and the prospects for U.S. steelmakers such as U.S. Steel (natch), AK Steel, and Steel Dynamics profiting from new "Section 232" trade protections levied by the Trump Administration. At first glance, this looks like very bad news for a steelmaker like ArcelorMittal (MT -1.16%), which has only 8% of its steelmaking assets located within the U.S. and safe from those trade protections. This may be why ArcelorMittal's stock is currently valued at less than 8 times earnings.
Is that a bargain price? Things aren't hopeless for Arcelor, after all. True, the company depends on U.S. customers to provide 22% of its sales, while 92% of the company's assets are outside of the U.S. This makes tariffs a real concern. But even if tariffs are raised on its sales to the U.S., 78% of Arcelor's revenues would remain abroad and safe from the tariffs' effect. Furthermore, Arcelor could probably ramp up production at its U.S. steel mills to avoid the bulk of those tariffs that would otherwise hurt its sales.
What worries me more about Arcelor is the fact that, while its stock looks cheap when valued on GAAP earnings, S&P Global Market Intelligence figures show that only about 20% of the company's net income is backed up by real free cash flow, which amounted to only $661 million over the past 12 months. With free cash flow weak, Arcelor has resorted to piling a lot of debt on its books -- about $12.1 billion net of cash, which makes its stock look even more expensive to me.
Arcelor, therefore, seems to me a case of a stock with a low P/E that's simply not as cheap as it looks.
Last but not least, we come to Fiat Chrysler (FCAU), the redheaded stepchild of Detroit's three biggest automakers. Much has been written in recent months about the compelling bargains offered by Ford and General Motors at their presently low P/E ratios -- a consequence of U.S. auto sales having possibly peaked. But at a price of only 7.7 times earnings, Fiat Chrysler stock is looking pretty attractive as well.
Unlike ArcelorMittal above, Fiat Chrysler stock doesn't have a problem with cash flow. In fact, S&P Global data show that over the past 12 months, Fiat generated more than $5 billion in real cash profits -- more than twice the $2.1 billion in GAAP earnings reflected on its income statement. Valued on its free cash flow, then, Fiat Chrysler sells for just a 3.3 times multiple to cash profits.
Granted, Fiat carries a heaping helping of debt -- $7.7 billion net of cash. But even so, the company's enterprise value-to-free cash flow ratio is a very modest 4.9, which means the stock may well be even cheaper than its P/E ratio makes it look. If analysts are right about their forecasts for 19% long-term growth, the time to buy Fiat Chrysler may be now --while investors are too busy worrying about slowing automotive sales to notice the attraction of growing automotive profits.