Although mathematically simple, taking a company’s price and dividing it by its earnings can tell an investor a great deal. The P/E ratio, as it is called, shows how much investors are willing to pay for a dollar of earnings. So, if a company has a stock price of $20 and earnings of $1.00, its P/E would be 20. Each dollar of earnings is worth $1 to the market. If that same company, trading at $20 per share, earned $0.50, however, the P/E would be 40—investors would be paying $2.00 for each dollar of earnings.
The price to earnings ratio is a valuation metric, helping to decipher if a stock is expensive or cheap. Although some use absolute metrics (a P/E over 20 is expensive, for example), P/E is most useful on a relative basis, comparing one company to its historical trends, to another company, or to an industry or market average. It is a way to measure that voting machine mentality of Wall Street about which Benjamin Graham wrote. The thought is that growth and momentum investors are willing to pay more for a dollar of today’s earnings to invest in a quickly growing company. A value investor, meanwhile, would prefer to wait until a company is “on sale” and trading at a low P/E multiple.
Every week Value Line publishes screens of the highest and lowest P/E ratios in the Index section of The Value Line Investment Survey. Although the common refrain is that value seekers should focus on the lowest P/E screen and growth and momentum investors should focus on companies with higher P/Es, this isn’t always true. The high P/E screen often turns up companies in the midst of a turnaround. So, while growth and momentum investors may find quickly growing companies on the high P/E list, value investors willing to sort through the 100 names that make the low P/E screen can also find some hidden gems.
A recent screen turned up rapidly growing companies like Under Armour (UA) and Green Mountain Coffee Roasters (GMCR). Hyatt Hotels (H) also turned up, which might interest value investors.
Under Armour manufactures sports apparel, footwear, and accessories for men, women, and children. The brand’s uses moisture-wicking synthetic fabrics in many of its styles as an alternative to traditional fabrication, which makes its products suitable for nearly any climate. Last year, international markets accounted for roughly 80% of 2010 sales.
The sports apparel company continued to build momentum during the first quarter, and posted double-digit top- and bottom-line gains over the period. Under Armour has broadened its portfolio, and we imagine that it will proceed to enter new categories that will extend its brand equity moving forward.
UA shares reached an all-time high of $80.00 in late April. But, the stock price has moderated somewhat following the announcement of first-quarter results. Despite the good news it posted for the March interim, many investors sought the opportunity to cash out of the equity. Even with the recent retreat, Under Armour boasts a lofty P/E ratio. Consequently, this stock doesn’t stand out for its long-term momentum.
Green Mountain Coffee Roasters
Green Mountain Coffee Roasters is a specialty coffee maker. The company roasts, packages, and distributes coffee under the Green Mountain Coffee Roasters, Timothy, and Newman’s Own Organic brand names. The company also sells Keurig brewing machines and K-Cup coffee systems. Its customers include supermarkets, specialty food stores, convenience stores, hotels, restaurants, universities, travel and office coffee service, and food service companies.
This stock has been on a tear over the past few years. Even with GMCR’s upward trajectory and high P/E multiple, the company is well poised for long-term growth. The specialty coffee company has partnered with key competitors, Starbucks (SBUX) and Dunkin’ Donuts. These joint ventures should help the company maintain its leading position in the single-serve coffee market (thanks to its K-Cup potion pack system). In addition, GMCR is in midst of creating a distribution agreement with Luigi Lavazza S.P.A., which will help the coffee brewer break into the single-serve espresso market.
Hyatt Hotels is a global hospitality firm that manages, franchises, owns, and develops branded hotels around the world. As the end of 2010, its portfolio consisted of 453 properties in 45 countries worldwide, with 127,507 rooms and units. The company’s full-service hotels operate under five world-recognized brands: Park Hyatt, Grand Hyatt, Hyatt Regency, Hyatt, and Andaz.
The lodging industry has experienced a good rebound over the past few months, in line with improved macroeconomic conditions. Better occupancy rates ought to continue to drive totals in the coming quarters. Thanks to robust demand overseas (specifically in China and Brazil), revenues climbed 4% year-over-year during first quarter. The hotelier posted $0.07-a-share profit (it merely broke even in the year-ago period).
Hyatt will probably widen its global reach in the coming months. In all, it expects to open 15 new hotels this year, and most of these are slated for outside of North America. We believe that this expansion will fortify its presence in underrepresented locations. Although these developments will likely be capital intensive in the near term, the additions ought to be accretive over the long haul.
At this juncture, investors seem to be willing to pay a premium for the hotelier’s stock, based on the elevated P/E figure. Indeed, Hyatt has experienced dynamic growth since it went public in November, 2009. But the hospitality chain may not be able to continue to keep up at its current pace. As such, we look for a lower (albeit still expensive) multiple over the 2014-2016 span.
At the time of this article's writing, the authors did not have positions in any of the companies mentioned.