Study after study has shown that stocks with low price-to-earnings multiples significantly outperform high P/E stocks. Research from my favorite investing guru, New York University professor Aswath Damodaran, pegged the outperformance at anywhere from 9%-12% per year, depending on the study period. That's big money we're talking about.
But you already know that you can't just go out and buy the stocks with the lowest multiples. Companies can trade at dirt cheap prices for a number of dire reasons, including low growth prospects, skepticism about earnings, or high risk of bankruptcy.
These dangerous stocks can quickly crater. Buy too many of them, and you'll increase your own risk of bankruptcy!
Thus, for a company to be truly undervalued, Damodaran says in his book Investment Fables: "You need to get a mismatch: a low price-to-earnings ratio without the stigma of high risk or poor growth."
Of course, you're unlikely to find any high-growth, low-P/E companies out there. But Damodaran suggests setting a reasonable minimum threshold for earnings growth, such as 5%. There are also various ways to minimize risk, including staying away from volatile stocks or companies with dangerous balance sheets.
The screen's the thing
We're looking for companies with low price-to-earnings multiples, but also a relatively low amount of risk, and the potential for reasonable growth. Our screen today will cover the best value plays in the semiconductor and semiconductor equipment industry, as defined by my nifty Capital IQ screening software.
There are 85 such companies with market caps topping $500 million on major U.S. exchanges. They have an average forward P/E of 19.1. Here are my parameters:
To stay away from bankruptcy risk, I used Damodaran's suggestion and only considered companies with total debt less than 60% of capital.
In hopes of capturing a reasonable amount of growth, I looked at Capital IQ's long-term estimates, and kept only companies expected to grow EPS at 5% annually or better over the next five years. Furthermore, I required at least 5% annualized growth over the past five years.
Of the 27 companies passing the screen, here are the 10 with the lowest forward price-to-earnings multiples:
Kulicke & Soffa Industries
Advanced Micro Devices (NYS: AMD)
Intel (NAS: INTC)
NVIDIA (NAS: NVDA)
Broadcom (NAS: BRCM)
RF Micro Devices (NAS: RFMD)
Fairchild Semiconductor International
Cypress Semiconductor (NAS: CY)
Applied Materials (NAS: AMAT)
ASML Holding NV
Source: S&P Capital IQ.
After discovering Kulicke & Soffa on this screen several months ago, I did further research and bought the company for my real-money, Rising Star portfolio.
To further stack the odds on your side, Damodaran says you can eliminate any companies that have restated earnings or had more than two large restructuring charges over the past five years. And if volatile swings in price cause you to lose sleep, consider only companies with betas less than one.
If you're interested in keeping up with any of these companies, add them to your free watchlist by clicking the appropriate "add" button in the table. For more on this industry, you may be interested in our research report "The Only Stock You Need to Profit From the NEW Technology Revolution." Click here to claim your free copy.
At the time thisarticle was published Fool analyst Rex Moore tweets but is not a twerp. He runs a real-money, Rising Star portfolio based on his screens. He owns no companies mentioned here. The Motley Fool owns shares of Kulicke & Soffa Industries and Intel. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Intel, Cypress Semiconductor, and NVIDIA. Motley Fool newsletter services have recommended writing puts in NVIDIA. Motley Fool newsletter services have recommended creating a bull call spread position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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