It's not a bad habit to tell Mr. Market, "I'm looking for something with a low P/E. What can you do for me?" The market always has a bargain bin, even if it's not pretty.
The "auto manufacturers" section includes Ford (NYSE:F), which sports a P/E of 7, and Honda (NYSE:HMC) with a 10. GM's (NYSE:GM) dive has also been in the news lately, but its P/E is thrown off by earnings restatements and a large loss in the first quarter.
Rich Smith also examined a few contenders in the steel industry earlier this month. OregonSteel (NYSE:OS) is definitely at the bottom of the barrel with a P/E of 3. Nucor (NYSE:NUE) boasts a 6, and Worthington Industries has reached stratospheric levels with a price-to-earnings ratio of 8.
Oil giants ConocoPhillips (NYSE:COP), ChevronTexaco (NYSE:CVX), and PetroChina all advertise P/E's of 8, while competitor Shell is showing a 10. Valero and Occidental are marked in the same range, with respective P/Es of 9 and 10.
For the sake of space (and eventual boredom) I've omitted a few other industries. Instead, let's address the more important question: how to evaluate these ratios.
If you were to invest in one of the companies above, you most certainly wouldn't do it based solely on a low P/E. These ratios indicate the multiple that the stock is trading at relative to lastyear's earnings. They don't mention anything about the next five years, though market participants might bid the stock up or down based upon expectations for future growth (or lack thereof). If you're feeling particularly ambitious, you could try to discern future growth/earnings via discounted cash flow analysis.
Mr. Market might be prone to periods of irrationality, but he's not entirely stupid. Sometimes a company is saddled with a low P/E for a good reason. The declining popularity of Ford's marquee-item SUVs, for example, recently earned the company a junk-status credit rating from Standard & Poor.
Factors such as this, and broader structural shifts in the economy and industry, make separating the wheat from the chaff difficult. Our very own Philip Durell understands this well. Experience and countless hours of research help him unearth true bargains for his Motley Fool Inside Value subscribers.
Before jumping to conclusions based on a single-digit P/E, step back and try to understand both the company you're considering and the historic and current changes in its industry. If you can honestly say that the price offers a margin of safety and that the earnings will be around for another 50 years, you're staring at a solid investment. But if the company doesn't measure up, tell Mr. Market you're just not interested.
Philip Durell's Motley Fool Inside Value is on us for the first 30 days. You get two stock recommendations each month, plus a free ticket to crash at Philip's place whenever you like. (Don't tell him I told you.) And yes, when we say free trial , we really mean it.
Foolish contributor Matt Thurmond doesn't own shares in any company mentioned in this article.
