One of the most time-honored investing strategies is finding stocks priced below their true value.  The Price/Earnings Ratio serves as the starting point for search but the P/E alone is never enough to separate a value stock from a value trap.  Some excited investors jump at the chance to buy a stock with a P/E multiple under 10 without considering what might need to happen to drive the price up.  Investors want to see growth over time and in the absence of growth or any reason to believe growth is forthcoming that low P/E stock may get a lot lower!

In short, some bargains are hard to resist while others are not always worth what you are paying.  Determining which is which is not easy but there are some indicators that can help.  To illustrate, we took the ASX 300 Market Summary Share Table from the Australian Financial Review for the trading day of 06 November and found over thirty stocks with P/E ratios under 10.  From the thirty we first isolated the companies that provide goods and services to the mining and resources sectors.  Here is the list:

Company

(Code)

P/E

(06/11)

Sector

(P/E as of 07/11)

P/B

(MRQ)

P/S

(TTM)

Share Price

52 Wk % Change

5 Yr Total Return

2 Yr Earnings Growth Forecast

5 Yr Est. P/EG

Ausdrill Ltd

(ASL)

 

4.6

Industrials (10.78)

 

0.52

 

0.38

 

$1.38

 

-51%

 

+8.9%

 

-10.1%

 

1.44

Ausenco

(AAX)

 

8.1

Industrials (10.78)

 

0.34

 

0.72

 

$1.55

 

-50%

 

-4.3%

 

-34.6%

 

-2.19

Austin Engineering

(ANG)

 

9.9

Industrials (10.78)

 

1.0

 

1.88

 

$3.77

 

-10%

 

+25.6%

 

+3.8%

 

-12.8%

Decmil Group

(DCG)

 

4.96

Industrials (10.78)

 

1.42

 

0.73

 

$2.25

 

-5%

 

+69.9%

 

+17.8%

 

2.9

Imdex Ltd

(IMD)

 

7.8

Materials

(11.58)

 

0.78

 

0.63

 

$0.71

 

-48%

 

19%

 

-26.8%

 

 

-1.03

Leighton Holdings

(LEI)

 

8.5

Industrials (10.78)

 

1.89

 

0.30

 

$17.07

 

+1%

 

-2.6%

 

+14.8%

 

2.13

Numbers generally provide more meaning when used in comparison.  First we can compare each stock’s P/E against the P/E for the overall Industrials Sector, the XNJ and the Materials Sector, the XMJ.  Industrials lag the overall ASX which currently shows a P/E of 16.07 so one would expect lower P/E ratios across the Industrial Sector.  However, large variances such as you see with Ausdrill Ltd (ASL) and Decmil Group (DCG) could be a sign there is more trouble with those stocks than can be explained by a troubled sector.  A year over year share price chart reinforces the concern:

 

Having raised the concern we now need to acknowledge that comparisons often suffer from the “apples to oranges” problem due to the mix of companies classified within a Sector.  In addition, while all six of the stocks in our table serve the mining and resources industries, there are differences in what they offer.  Ausenco Ltd (AAX), Leighton Industries (LEI) and the Decmil Group (DCG) offer a variety of engineering and construction services and as such should be hit the hardest by the contraction in mining expansion projects.  

Imdex Limited (IMD) provides drilling fluids and chemicals; Austin Engineering (AAX) provides a variety of heavy equipment; and Ausdrill Ltd (ASL) provides production and exploration services, including drilling.  With the miners cutting back on exploration one would expect ASL to suffer the most amongst that group.  On 07 November Ausdrill’s stock price plunged 24% following a hefty profit warning due to worse than anticipated spending reductions across the mining industry.  

The remaining numbers we can look to in order to shed some light on potential bargains are the forward looking estimates, and to a lesser extent to past historical performance.  The company that looks most promising is the Decmil Group, having returned a handsome 69% to its investors over the past five years along with a healthy two year growth forecast, despite challenging conditions.  The two year projections are based on Earnings per Share (EPS) estimates while the 5 Year Price to Earnings Growth Ratio (P/EG) is based on anticipated growth rates.  However, both come from analysts and for some small cap stocks that can mean the estimate comes from one or two individuals.  Thomson/First Call reports eight analysts covering Decmil, with three Hold recommendations, four Buys, and one Strong Buy.  The company’s dividend yield is 4.96%, fully franked.

Leighton Industries is definitely worth a look.  While its five year shareholder performance is nothing to be proud of, longer term holders of this stock have fared better.  Here is a ten year chart comparing Decmil and Leighton:

 

While Leighton has more analyst coverage, the company also has some bearish analyst outlooks.  Of the 15 analysts covering the stock, two have Sell ratings on LEI; four have Underperform ratings; six recommend Holding the stock; and three have Buy ratings.  Leighton’s dividend yield is 5.96%, 50% franked in FY 2012.

There were three resource miners (excluding gold miners) on the ASX 300 Share Table Summary with P/E ratios under 10.  Here they are:

Company

(Code)

P/E

(06/11)

Sector

(P/E as of 07/11)

P/B

(MRQ)

P/S

(TTM)

Share Price

52 Wk. % Change

5 Yr. Total Return

2 Yr. Earnings Growth Forecast

5 Yr. Est. P/EG

Aquila Resources (AQA)

 

3.0

Energy

(13.76)

 

1.14

 

N/A

 

$2.29

 

-3%

 

-4.6%

 

 

-1.01

Fortescue Metals

(FMG)

 

9.1

Materials

(11.58)

 

3.44

 

2.24

 

$5.7

 

+46%

 

23.9%

 

32%

 

0.58

Mt Gibson Iron

(MGX)

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