By Dee Gill
The price/earnings ratio makes a simple first screen for many investors who want to narrow a list of potential buys. If the price of the shares divided by annual earnings creates a number that’s higher than that calculation for other companies in its sector, the stock is an easy toss.
But it’s also a quick way to lose out on some solid investments.
Too much reliance on the PE ratio cripples value investors because it misses opportunities for steady dividends. The PE doesn’t see those payouts – essentially refunds on the price -- at all.
Nor can the PE ratio account for growth. A company whose earnings are doubling year over year will most certainly create a bigger increase in its share price than one with flat figures, making it worth a higher valuation. Comparing the PE ratios of these two companies yields little useful information.
To make the point, YCharts Pro has dug through its own valuations and found five stocks it rates as attractive despite quite high PE ratios. Like all stocks that YCharts Pro rates highly, each of these companies has good scores on most of their balance sheet fundamentals.
TransAlta Corp. (TAC)
With a share price approaching 22 times earnings, Alberta-based TransAlta is one of the most expensive electric utilities one can buy now. So what’s so special about these shares?
The dividend. Its dividend yield, at about 5.5%, is one of the best in the sector.
The company, which provides power in Canada, the U.S., Mexico and Australia, recently reported strong earnings and optimism about recovering markets. But watch to make sure earnings growth really happens. TransAlta will eventually need that money to continue these nice dividend payments.
Chemical Financial Corp. (CHFC)
Yes, shares of this Michigan-based bank look quite expensive when comparing PE ratios in the banking sector. But it’s this chart that makes investors believe they’re worth it.
As an industry, bank earnings are expected to rise now that the problem loans are shrinking rather than growing. But revenue growth is hard to come by in this sector. While that big jump in Chemical Financial’s revenue comes mainly from a merger completed in the third quarter of 2010, there are unrelated sales gains in there too.
With growth as a factor, a price to earnings growth ratio is a better indicator of value in these shares. Chemical Financial’s PEG is less than 0.3, making the shares look very cheap. A dividend yield approaching 4% also makes the shares a better value than they first appear.
China Life Insurance Co. (LFC)
It’s almost impossible to find a life insurance company as expensive on PE valuation as China Life, the second largest insurer in the world and market leader in China. Its ADRs tend to trade above 20 times earnings in a sector where a PE ratio of 14 is more normal.
But the company’s sales are growing with China’s middle class, as more people there look to protect assets or buy annuities for retirement.
An investment in China Life is in some ways more risky than that of a U.S. company, in part because it carries no reinsurance to cover catastrophic events. Investors are betting on rampant growth to make up for the risk.
NuStar Energy L.P. (NS)
Pipeline valuations vary wildly, but with a price at more than 21 times past earnings, NuStar is not a cheap stock. NuStar operates pipelines and oil storage terminals in six countries, and it also owns a couple of asphalt refineries.
As a master limited partnership, NuStar reports earnings and distributions slightly differently from other traded companies, but its sales and profits have been solid. For investors, the payouts that consistently outstrip T-bills by a long shot make the company worth a premium price.
Black Hills Corp. (BKH)
Electric and gas utility Black Hills has been a dividend darling for several years now, and its current yield makes its high PE ratio much less consequential.
Investors have been impressed lately at the company’s ability to grow profits and increase cash flow even with flat revenues. The share price has moved up this year.
Dee Gill is an editor for the YCharts Pro Investor Service.