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It seems too good to be true at first. You run a stock screener and find a company with a P/E under 5 trading on the U.S. markets. It has a recognizable name and a solid balance sheet. Why is it so undervalued, you ask? Many savvy investors will know the potential answers. In many cases, the reason is a tax benefit, rather than a tax expense that cuts into earnings. This is a positive factor that boosts the earnings for the company in a one time event. While the Price to Earnings (P/E) ratio is technically now much lower with the tax benefit, the earnings are misleading because that tax benefit is a one time event. Many investors who simply rely on the P/E as a measure of valuation are often disappointed and shocked when they see such a drastic decrease in net income quarter over quarter as a result of the tax incentive going away. When choosing a stock based on earnings, be sure to check the income statement for a positive number in the tax expense area. If large enough, it could drastically distort the company's organic earnings.

Here are a few companies trading at low P/E ratios (under 5) because of a one time tax expense that bolstered earnings:

Callon Petroleum Co. (NYSE:CPE)

(click images to enlarge)

cpe yearly chart

According to Yahoo Finance, Callon Petroleum has a P/E ratio of 3.04. Callon made roughly $83.8 million in net income in the last four quarters, $63 million of which was from a positive income tax expense. Roughly 75% of its earnings were from a one time event. Excluding the one time tax event, the stock has a P/E ratio closer to 12.

Data and chart from Yahoo Finance

Sirius XM Radio Inc. (NASDAQ:SIRI)

siri 1 year chart

According to Yahoo Finance, Sirius has a P/E ratio of 4.4. The company made roughly $3.4 billion in net income in the last four quarters, $3 billion of which was from a positive tax expense. In other words, roughly 88% of its net income was from a one time event. Excluding the one time tax event, Sirius has a P/E ratio closer to 22, a drastically different number.

Data and chart from Yahoo Finance

Denny's Corporation (NASDAQ:DENN)

denny

According to Yahoo Finance, Denny's has a P/E ratio of 4.45. Denny's made roughly $110.5 million in net income in the last four quarters, $85 million of which was from a one time positive tax expense. Roughly 76% of the company's net income was from this one time event. Excluding the one time tax event, Denny's has a P/E ratio closer to 19, again drastically higher than the P/E posted because of the one time tax event.

Data and chart from Yahoo Finance

Conclusion

Investors need to be wary when they simply go off of the ratios provided by sites such as Yahoo Finance and stock screeners. These one time events are misleading to some investors who are not well versed. People who may be thinking they are getting a great value with a stock at a P/E under 5 may be instead getting a stock with a P/E of 19 without even knowing it. Investors may then see this as a negative and sell the stock, thinking the business was hurt. These events can also lead to great short trades for people who understand these occurrences to be a one time tax event. If the "real" P/E of the stock gets significantly higher than that of its peers due to the event, taking a short position could be a wise choice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.