Source: Flickr user Andreas Poike.
The Dow Jones Industrial Average has had quite the month, with a peak-to-trough closing difference since mid-August of nearly 1,900 points. It's the first time since Oct. 2011 that Wall Street and investors have witnessed a true correction.
While the correction has short-term traders and those utilizing high levels of margin in their investment portfolios anxiously biting their nails, long-term investors are out and about digging around for what could be attractively priced stocks. Presumably, with the Dow more than 10% off its all-time high, there could be quite a few multinational companies within the storied index that are priced just right.
We're going to use one of the simplest measures of value, the forward P/E ratio, to briefly examine the three cheapest stocks in the Dow Jones Industrial Average. But before we do that, a quick word of caution on the forward P/E: It's not a perfect measurement of value. Although a forward P/E ratio offers a quick comparison of valuation to profitability, it doesn't take into account future growth rates; so a company's sales could be contracting and this ratio wouldn't tell us that.
Additionally, some sectors naturally trade at lower forward P/E ratios than others. Typically, this is a function of long-term growth prospects. In other words, we'd expect healthcare and tech stocks to typically have higher forward P/Es because they could offer high long-term growth prospects, while the banking sector, which is filled with slow-and-steady growth stocks, tends to trade at lower P/E multiples.
Now, without further ado, the Dow stocks with the lowest forward P/E:
Source: IBM.
IBM (IBM 1.44%)
Arguably, the most attractive valuation in the Dow Jones Industrial Average belongs to "Big Blue" -- IBM -- with a forward P/E of nine. But as noted above, IBM's low P/E covers up the fact that its top-line growth is stagnant.
IBM is in the process of transitioning out of older enterprise software and into the cloud, where enterprise demand is expected to keep growing throughout the decade. Even though IBM is seeing substantial growth in its cloud business -- IBM's cloud revenue rose 70% on an apples-to-apples basis in the second-quarter and is generating about $4.5 billion per year based on its extrapolated results -- it still accounts for a relatively small portion of revenue relative to its legacy software business. In other words, without additional cost-cutting, it could be difficult for IBM to grow its EPS during the next couple of years.
On the flipside, IBM has Warren Buffett in its corner. Buffett's Berkshire Hathaway owns almost 80 million shares of IBM, or 8.22%. Buffett has a knack for picking companies that are attractively valued, pay a solid dividend, and are cash flow cows. In IBM's case, it's generated at least $12.7 billion in free cash flow during the past seven years, and it's sporting a market-topping 3.6% dividend yield.
Personally, I wouldn't expect a dramatic reversal in IBM's stock price anytime soon, but I do believe there's long-term value to be had here if you remain patient. IBM has executed on multiple turnarounds before, and I suspect it can do so once again.
Source: Flickr user www.vpsi.com.
Goldman Sachs (GS +2.01%)
Nipping at IBM's heels in terms of value is investment banking giant Goldman Sachs, with a forward P/E of just 9.2. What's been ailing Goldman Sachs?
Primarily, it's been doing just fine until the recent correction, which would imply that emotions, rather than fundamentals, have been the driving force pushing Goldman's stock price lower. Perhaps the only consistent negative for Goldman in recent quarters has been falling fixed-income, currency, and commodity revenue (known as its FICC business), as well as weaker trading revenue. Goldman continues to stick by its trading business, but it's clearly been a drag the last couple of quarters.
However, there looks to be plenty to like about Goldman Sachs, too. Through the first-half of 2015, Goldman ranked No. 1 in completed mergers and acquisitions, and I doubt we're going to see much of a drop-off in the second-half of the year in M&A, with valuations actually falling, and some companies holding a veritable smorgasbord of cash.
Goldman is also reasonably priced relative to its tangible book value. Based on a TBV of $160.11 at the end of Q2, Goldman's price-to-TBV of approximately 1.15 is about 40% of where it was prior to the 2007 market meltdown. This isn't to say that Goldman deserves a premium valuation, either, but that a reasonable expectation could be found somewhere in-between.
Source: Chase.
JPMorgan Chase (JPM +1.81%)
Lastly, national banking giant JPMorgan Chase offers investors one of the lowest forward P/E ratios in the Dow, at 9.7. Of course, banks historically grow at a slower pace than most sectors, so this might partially explain its sub-10 P/E ratio.
Perhaps the biggest concern facing the banking sector at present is the fear of a global slowdown. Recently, weak manufacturing data in China has left the world's No. 2 economy scrambling for answers in regards to reigniting economic growth.
Also, JPMorgan and other U.S. banks have eagerly been awaiting a rate hike from the Federal Reserve. Higher interest rates should be a positive for banks, as it will boost their interest-based income. Thus, the longer the Fed waits, the more pressure bank stocks will continue to feel from anxious short-term traders.
But is JPMorgan Chase worth your attention? If you have a long-term investing horizon, then I see no reason why you shouldn't give it a closer look. In JPMorgan's latest quarter, it reported a 12% increase in core loans on a year-over-year basis, a 9% increase in consumer and business banking deposits, and a $931 million reduction in non-interest expenses (or 6%) on a year-over-year basis. With the expectation of a rate hike in the somewhat intermediate future, and the company cutting back on branches and pushing its lower-cost and more convenient mobile platform, there could ultimately be a lot to like here.
