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What are we looking for?
Companies that look cheap in comparison to their earnings. We performed a similar screen last month, with the results limited to Canadian companies. Today, we screen for U.S.-based companies.
Independent studies have demonstrated that selecting companies based on a value-oriented yardstick, such as a low price-to-earnings (P/E) ratio, will result in a portfolio that is likely to outperform the market averages over the next 12 months.
However, successful investors know that no single metric is infallible. For instance, some companies are "value-traps" that trade at low P/E ratios, but for good reasons.
To avoid these traps, we looked for companies that are not only cheap but meet basic criteria for quality. For instance, a low P/E can sometimes signify slow earnings growth or too much debt, so we filtered out companies with these characteristics.
The screen
Before ranking U.S.-based companies to find those with the lowest P/Es, my colleague Alvin Lau and I used the S&P Capital IQ Screener to exclude firms with:
-compound earnings growth of less than 5 per cent a year for the past five years;
-a balance sheet with greater than 30 per cent debt to total capital;
-a market capitalization lower than $1-billion (U.S.).
More about S&P Capital IQ
S&P Capital IQ offers a comprehensive set of tools for fundamental analysis of global securities as well as idea generation and workflow management. Its Web- and Excel-based platform provides access to both real-time and historical information on companies, markets, transactions and people around the world.
What did we find?
This particular screen produced 237 results, from which we selected the 15 companies with the lowest P/E ratios. All companies that made the list have a P/E well below 10, but their average five-year earnings-per-share growth rate is an impressive 23 per cent a year.
None of these companies is guaranteed to beat the market, but screens such as this can be a useful tool for pointing out interesting candidates for further research. Before investing in any of these firms, do your own reconnaissance. In particular, make sure to check trailing earnings to make sure that they are not being skewed by one-time or non-recurring gains.