Learning how to gauge a stock’s price-to-earnings ratio can help empower your stock picks. Here’s how price-to-earnings ratios work, along with five low P/E stocks to consider.
What is a price-to-earnings ratio?
A stock’s price-to-earnings ratio, or P/E ratio, directly reflects a stock’s earnings relative to its price. Essentially, it expresses how much current investors are willing to pay for $1 of profit from that company. Investors use this metric to compare stock valuations and to help them gauge if a stock is trading at a discount. In short, a low P/E stock is considered inexpensive. A high P/E stock is considered expensive. You can also use this valuation tool on a trailing basis from the previous year’s earnings. Or you can use it as a forecasting tool for future valuations. These variations of P/E ratios are called the trailing price-to-earnings ratio and the forward price-to-earnings ratio.
Calculating the P/E ratio
A stock’s P/E ratio can be calculated by dividing its market price per share by its earnings per share (EPS). For example, let’s say Company X’s stock currently trades at $10 per share. Last year, it reported earnings of $1 per share. When we divide Company X’s $10 share price by its $1 per share in earnings, we get a price-to-earnings ratio of 10:1 — meaning the stock is trading at 10 times the earnings on a trailing basis. Now, let’s say we have forward guidance from the company. Company X says it expects to report earnings of $5 per share for 2021. To find its forward P/E ratio, you use the same equation with the new earnings per share figure: $10 share price divided by $5 per share in earnings, which gives us a price-to-earnings ratio of two. The stock is trading at two times the earnings on a forward-looking basis. *Note: companies with negative full-year earnings will not have calculable P/E ratios.
P/E ratios by sector
Keep in mind, a “cheap” stock that trades at five times the earnings isn’t necessarily a better deal than a “pricey” company that trades at 30 times the earnings. And that’s partly because different sectors trade at inherently different valuations. Growth industries like tech garner much higher premiums for stocks because of their growth potential. Investors are willing to accept bigger P/E ratios for Amazon (AMZN) because it delivers above-average annual growth compared to a mature blue-chip stock like JPMorgan (JPM). When evaluating a stock’s P/E ratio, consider the ratios prevalent across the entire sector or industry. This way, you’ll have better context for understanding the ratio.
Comparing companies by P/E ratios
So, how can P/E ratios help you compare the value of two different stocks? Let’s take a look at another hypothetical example. Let’s say Company A and Company B both belong to the tech sector and sell shares for $20 apiece. At first glance, you might assume the stocks are equally valuable. But if we dig into each company’s P/E ratio, we uncover a different story. Company A reported earnings of $5 per share, while Company B reported earnings of $10 per share. This means Company A’s P/E ratio is four, while Company B’s P/E ratio is two. In this instance, even though their shares are priced identically, it would be more practical to buy shares from Company B, as investors receive $10 of earnings per share purchased instead of the $5 of earnings per share offered by Company A.
Limitations of P/E ratios
Price-to-earnings ratios matter but aren’t infallible — and they’re far from the only metric you should rely on to assess the value of a stock. There are numerous elements a P/E ratio doesn’t account for:
Misleading balance sheets. An unhealthy balance sheet with lots of debt or weak cash flow may influence a P/E ratio.
Major market events. Events that impact the economy may cause drastic fluctuations in stock prices, contributing to misleading P/E ratios.
Outsized or undersized growth. Investor may be willing to pay more for a company growing quickly, so it’s worth know the PEG ratio as well as P/E. Price/earnings to growth ratio can be calculated by dividing a stock’s P/E ratio by its earnings growth. This formula uses the same information as the P/E ratio while simultaneously factoring in a company’s earnings growth.
5 stocks with low P/E ratios
When selecting stocks with low P/E ratios, it’s important to remember that just because a stock is cheap doesn’t mean it’s a keeper. These are 5 stocks carrying low P/E ratios (based on the most recent full fiscal year results) that have growth potential for 2021.
Company details: One of the oldest automakers, General Motors follows the trend of most car stocks, which have been relatively cheap relative to earnings since the financial crisis of 2008.
Company summary
General Motors Company designs, builds, and sells trucks, crossovers, cars, and automobile parts; and provide software-enabled services and subscriptions worldwide. The company operates through GM North America, GM International, Cruise, and GM Financial segments. It markets its vehicles primarily under the Buick, Cadillac, Chevrolet, GMC, Baojun, and Wuling brand names. In addition, the company sells trucks, crossovers, cars, and automobile parts through retail dealers, and distributors and dealers, as well as to fleet customers, including daily rental car companies, commercial fleet customers, leasing companies, and governments. Further, it offers range of after-sale services through dealer network, such as maintenance, light repairs, collision repairs, vehicle accessories, and extended service warranties. Additionally, the company provides automotive financing; and software-enabled services and subscriptions. General Motors Company was founded in 1908 and is headquartered in Detroit, Michigan.
Company details: Pharmacy chain with thousands of stores. A well-developed company, CVS has had mixed annual earnings growth over the last five fiscal years, which could contribute to its lower valuation.
Company summary
CVS Health Corporation provides health solutions in the United States. It operates through Health Care Benefits, Health Services, and Pharmacy & Consumer Wellness segments. The Health Care Benefits segment offers traditional, voluntary, and consumer-directed health insurance products and related services. It serves employer groups, individuals, college students, part-time and hourly workers, health plans, health care providers, governmental units, government-sponsored plans, labor groups, and expatriates. The Health Services segment offers pharmacy benefit management solutions, including plan design and administration, formulary management, retail pharmacy network management, specialty and mail order pharmacy, clinical, disease management, and medical spend management services. It serves employers, insurance companies, unions, government employee groups, health plans, prescription drug plans, Medicaid managed care plans, CMS, plans offered on public health insurance, and other sponsors of health benefit plans. The Pharmacy & Consumer Wellness segment sells prescription and over-the-counter drugs, consumer health and beauty products, and personal care products. This segment also distributes prescription drugs; and provides related pharmacy consulting and other ancillary services to care facilities and other care settings. It operates online retail pharmacy websites, LTC pharmacies and on-site pharmacies, retail specialty pharmacy stores, compounding pharmacies and branches for infusion and enteral nutrition services. The company was formerly known as CVS Caremark Corporation and changed its name to CVS Health Corporation in September 2014. CVS Health Corporation was incorporated in 1996 and is headquartered in Woonsocket, Rhode Island.
Company details: Retail chain focused on affordable goods across food, home items, electronics and more. Annual earnings growth has been somewhat slow over the last five years, while the company saw good sales growth in its last fiscal year. Overall, this could represent value for shareholders if its current trend continues.
Company summary
Big Lots, Inc., through its subsidiaries, operates as a home discount retailer in the United States. The company offers products under various merchandising categories, such as furniture category that includes upholstery, mattresses, home décor, case goods, and ready-to-assemble departments; seasonal category, which comprises patio furniture, gazebos, Christmas trim, lawn and garden, and other holiday departments; soft home category consists of apparel, hosiery, jewelry; frames, fashion and utility bedding, bath, window, decorative textiles, and area rugs departments; and food category that includes beverages and grocery, specialty foods, and candy and snacks departments. It also provides merchandise under the consumables category, which comprises health, beauty and cosmetics, plastics, paper, pet, infant, stationery, and chemical departments; and hard home category, including small appliances, tabletops, food preparation products, home maintenance and organization products, toys, electronics departments, and other offerings. Big Lots, Inc. was founded in 1967 and is headquartered in Columbus, Ohio.
Company details: Retailer focused primarily on electronics, Best Buy carries one of the higher P/E ratios on this list at 16.5 but falls below TDAmeritrade’s listed specialty retail industry average of 39.14. It is one of the last remaining brick-and-mortar tech retailers that continues to perform well.
Company summary
Best Buy Co., Inc. engages in the retail of technology products in the United States, Canada, and international. Its stores provide computing and mobile phone products, such as desktops, notebooks, and peripherals; mobile phones comprising related mobile network carrier commissions; networking products; tablets covering e-readers; smartwatches; and consumer electronics consisting of digital imaging, health and fitness products, portable audio comprising headphones and portable speakers, and smart home products, as well as home theaters, which includes home theater accessories, soundbars, and televisions. The company's stores also offer appliances, such as dishwashers, laundry, ovens, refrigerators, blenders, coffee makers, vacuums, and personal care; entertainment products consisting of drones, peripherals, movies, and toys, as well as hardware and software, and virtual reality and other software products; and other products, such as baby, food and beverage, luggage, outdoor living, and sporting goods. In addition, it provides delivery, installation, memberships, repair, set-up, technical support, health-related, and warranty-related services. The company offers its products through stores and websites under the Best Buy, Best Buy Ads, Best Buy Business, Best Buy Health, Buy Mobile, CST, Current Health, Geek Squad, Lively, Magnolia, Pacific Kitchen, Home, TechLiquidators, and Yardbird brands, as well as domain names comprising bestbuy.com, currenthealth.com, lively.com, techliquidators.com, yardbird.com, and bestbuy.ca. The company was formerly known as Sound of Music, Inc. Best Buy Co., Inc. was incorporated in 1966 and is headquartered in Richfield, Minnesota.
Company details: Large-cap insurance company based on property and casualty insurance, life insurance, health insurance and more. In all, the stock carries a low P/E ratio because the company’s top-line growth has been slow over the last few years, while a declining share count and emphasis on driving earnings per share have driven the price-to-earnings ratio down.
Company summary
The Allstate Corporation, together with its subsidiaries, provides property and casualty, and other insurance products in the United States and Canada. It operates in five segments: Allstate Protection; Protection Services; Allstate Health and Benefits; Run-off Property-Liability; and Corporate and Other segments. The Allstate Protection segment offers private passenger auto and homeowners insurance; other personal lines products; and commercial lines products through agents, contact centers, and online. The Protection Services segment provides consumer product protection; protection and insurance products, including vehicle service contracts, guaranteed asset protection, road hazard tire and wheel, and paintless dent repair protection; and roadside assistance, device and mobile data collection services, and analytic solutions using automotive telematics information, as well as identity theft protection and remediation services. This segment also offers its products under various brands, including Allstate Protection Plans, Allstate Dealer Services, Allstate Roadside, Arity, Avail, and Allstate Identity Protection. The Allstate Health and Benefits segment provides life, accident, critical illness, short-term disability, and other health insurance products; stop-loss and fully insured group health products to employers; and short-term medical and medicare supplement insurance to individuals. The Run-off Property-Liability segment offers property and casualty insurance coverage that primarily relates to policies written during the 1960s through the mid-1980s. The Corporate and Other segment provides debt services, as well as non-insurance operations. It sells its products through agents, independent agents, call and contact centers, retailers, direct to consumer, wholesale partners, and affinity groups, as well as through online and mobile applications. The Allstate Corporation was founded in 1931 and is headquartered in Northbrook, Illinois.
To buy any of these or other stocks, you’ll need a brokerage account. Most broker sites and apps also include tools to make it easy to look at data like stock P/E ratios.
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Bottom line
When selecting stocks for your portfolio, P/E ratios may help inform your picks. But this metric isn’t foolproof, and P/E ratios tend to fluctuate by sector. To invest, review your brokerage account options to find the platform best equipped to help you meet your investment goals.
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Shannon Terrell is a lead writer and spokesperson at NerdWallet and a former editor at Finder, specializing in personal finance. Her writing and analysis on investing and banking has been featured in Bloomberg, Global News, Yahoo Finance, GoBankingRates and Black Enterprise. She holds a bachelor’s degree in communications and English literature from the University of Toronto Mississauga. See full bio
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