By Matt Doiron
Sometimes a string of bad performance, or poor public relations, or external industry events contribute to a sharp decline in the price of a stock. While some declines may be justified, momentum trading can sometimes push the share price down to the point where a company becomes a buy if investors are willing to stay in for the long-term in case the stock keeps dropping.
One way to see if a stock has been oversold due to recent events is to see if its forward price-to-earnings ratio is at a good low value. Wall Street sell-side analysts provide estimates of forward earnings that arguably are a better measurement of value than past earnings; after all, buying into a company gives an investor ownership of its future cash flows, not its past cash flows. Of course, relying on forward P/E ratios for valuations means that an investor is depending on the consensus of sell-side analysts, who can be quite wrong and are often accused of being optimistic regarding a company's prospects. We think forward P/E ratios, as with trailing P/E ratios, are at least a metric that can be compared across stocks and provide a signal that a stock might be worth further analysis.
Using Fidelity's market data, here are seven U.S. stocks which are in the bottom 20% of the market in terms of trailing 52-week returns and forward P/E multiples and have market caps of at least $2 billion:
Peabody Energy (NYSE:BTU)
Green Mountain Coffee Roasters (NASDAQ:GMCR)
Pan American Silver (NASDAQ:PAAS)
Walter Energy (NYSE:WLT)
Precision Drilling (NYSE:PDS)
United States Steel (NYSE:X)
Cliffs Natural Resources (NYSE:CLF)
The coal miners - Peabody, Cliffs, and Walter - and U.S. Steel are the easiest to explain. The demand for steel has declined, which in turn means there is less need for the metallurgical coal (and, in the case of Cliffs, iron ore) that is used in the steel smelting process. These four companies have suffered accordingly. Analysts apparently agree that the demand for steel, and therefore for metallurgical coal, is on its way back and that is why these businesses only command single-digit multiples on their forward earnings. We aren't as optimistic as analysts. Apple's (NASDAQ:AAPL) iPhone sales in China declined by 28% quarterly, which points to a slowdown in Chinese economy. We don't think steel and coal prices can recover if Chinese economy doesn't change its course.
Green Mountain Coffee Roasters is a familiar story to market watchers. David Einhorn's recommendation to short the company last year was a catalyst that has driven the stock down 80%. While the share price at that time was unsustainable due to concerns about the business going forward, momentum may have carried the decline too far. If sell-side analysts are right, the company now trades at below six times forward earnings, with concerns about the future generally being company- rather than industry-related. The company also has very high short interest - might a short squeeze be in order?
Pan American Silver trades at a trailing P/E of 5 and a forward P/E of 8. Why? Because silver prices have fallen 32% in the last year, and many of Pan American's mines are in risky countries such as Mexico and Bolivia. While the company's revenue in its most recent quarterly report was up, its earnings fell by nearly 50% compared to the same quarter in the previous year. Royce & Associates, managed by Chuck Royce, has owned over 10 million shares of the stock for a year and is probably ready for the company to start reporting better numbers and get on track to meet analyst expectations.
Precision Drilling provides contract drilling services on land in Canada and the U.S. While its industry is growing as oil and gas activity in North America heats up, and it recently reported earnings up 10% from the same period in the previous year, its stock price has only just started to recover from a decline from above $16 a year ago to $6. Sell-siders say that it is cheaply priced at a forward multiple of about 7, and its trailing multiple looks good as well at just below 10. We think this stock deserves a good look from investors.