Everyone loves a good cheap stock, and stocks trading for a P/E of 10 or so seem “good and cheap.” But which cheap stocks are the best ones to buy?
I recently ran a screen seeking brand-name stocks selling for about 10 times earnings or below and projected to grow earnings at better than 10% annually over the next five years (the textbook definition of a “value stock” with a PEG ratio of less than 1.0). Today, I’ll put two pairs of these potential value investments to the test, crunch some numbers, and decide which are the best low-P/E stocks to buy in June.
AutoNation or Group 1 Automotive?
Our first pair of contenders today come from the world of automotive retail — AutoNation (NYSE:AN), which is the nation’s largest car seller, and its smaller rival Group 1 Automotive (NYSE:GPI). Both companies have recently reported earnings, and their news wasn’t great. Sales were essentially flat year over year at AutoNation, and down 3% at Group 1.
The “good” news is that both stocks have declined in price after reporting their earnings, making them cheaper for new investors to buy. But which one should you buy? For value investors, it’s not even a contest.
Priced at just 9.0 times trailing earnings, Group 1 Automotive stock costs 6% less than AutoNation stock, which sports a 9.6 P/E ratio. Analysts who follow both stocks also expect Group 1 to outgrow its rival over the next five years — 17.4% long-term growth versus 10.2% for AutoNation. On top of all that, Group 1 pays its shareholders a modest 1.6% dividend, while AutoNation pays no dividend at all.
With all the pluses in its favor, and no minuses that I can find, there’s really no reason an investor shouldn’t feel confident choosing Group 1 Automotive stock over AutoNation.
Toyota Motor Corporation or Honda Motor Co.?
Once again, we’re looking at two similar companies, both apparently cheap stocks, and both operating in the same sector of the market (again, the automotive sector). But whereas picking Group 1 Automotive stock over AutoNation was a no-brainer, this second contest is a bit of a closer call.
The contest starts off similarly, with Toyota Motor stock selling for 9.7 times earnings, and Honda Motor selling at a modest discount to Toyota’s valuation — 9.0 times earnings. Honda also boasts a better price-to-sales ratio, and a cheaper price-to-book ratio. So at first, this seems a clear-cut “value” case in favor of Honda — but things quickly get trickier.
For value investors with a bias toward growth at a reasonable price, Honda’s predicted earnings growth rate of 22.9% is blazing fast, but it’s still not as fast as the 33.7% growth rate projected for Toyota. Assuming these projections are accurate (and do be aware that different data providers provide different estimates, so take these projections with a grain of salt), the difference in projected growth rates suggests that despite Honda’s cheaper P/E ratio, long-term investors might actually be better off investing in Toyota stock instead, because its earnings could grow faster than Honda’s.
For value investors who also like a bit of dividend income in their investment, there’s a second reason to prefer Toyota over Honda, in that Toyota’s annual dividend yield of 3.6% is more generous than Honda’s 3.1% payout.
All that said, in the end I’m still inclined to favor Honda as the better low-P/E stock because of its higher quality of earnings. According to data from S&P Global Market Intelligence, Honda’s earnings are backed up by $3.5 billion in trailing free cash flow (cash profits, as opposed to GAAP “accounting profits”). In contrast, S&P Global data shows Toyota generating no cash profit whatsoever over the past 12 months, and instead burning $1.1 billion in cash during this period.
The upshot for investors
After comparing the four stocks — AutoNation versus Group 1, and Toyota versus Honda Motor — I’m inclined to pick Group 1 and Honda Motor as the best “low-P/E” stocks to buy. But why should you be buying them in June, in particular?
The reason is that recent weeks (and months) have seen a significant slide in the prices of stocks related to the automotive industry. Fact is, all four of these stocks have gotten significantly cheaper since about February of this year. The slide in stock prices got significantly more pronounced after automakers reported their May sales tallies, with a further step down last week, after Morgan Stanley made some rather downbeat predictions about the future for car sales.
These depressed prices may not last long, however, if predictions of the automotive industry’s demise prove to be exaggerated. With prices low today, and growth prospects still strong for all four of these stocks, I think June might be a great time to go shopping for bargains.