Are these 5 ASX stocks cheap or value traps?

Low P/E stocks can be a fertile hunting ground – or trouble

Mike King

Mike King is a Fool.com.au Investment Analyst and Writer. He caught the investing bug more than a decade ago, at a time when the U.S. had invaded Iraq and fear reigned in the markets. His initial success as the markets took off encouraged his passion and thirst for knowledge. With 13 years behind him at one of Australia's largest domestic banks, Mike's passion for stocks led him to join a boutique funds management firm, where he stayed for four years. A seven-year stint in equity research at one of the largest investment banks in the world followed that, giving Mike a thirst to pursue his passion further. Mike holds a Diploma in Applied Finance and Investment and a Graduate Certificate in Financial Planning. His passion is to help retail investors invest better, and that passion was one of his primary reasons for joining The Motley Fool Australia in late 2011. Mike has written thousands of articles since joining, including for Fairfax Media, Yahoo!7, Ninemsn and has also appeared on ABC's The Business. You can see all of Mikes' holdings here

Published May 17, 2012 9:03 am AEST

There have been many studies done on the returns of stocks with low Price to Earnings (P/E) ratios, with the overwhelming conclusion that portfolios containing low P/E stocks consistently out-perform those with high P/E stocks. Bruce Greenwald's book Value Investing: From Graham to Buffett and Beyond contains much more information on that subject than I can include in this article, and it's a worthwhile read.

The S&P / ASX 200 Index (Index: ^AXJO) (ASX: XJO) is currently trading on a trailing P/E of 13.2 (as at the 8^th May 2012). All of the following stocks are trading at less than half of the index average. Some are trading at less than book value, and all appear to be priced for possible extinction – or at least long term poor performance

United Overseas Limited (ASX: UOS) is currently trading at around 38 cents, has a P/E of 4.1 and a dividend yield of 5.3%. We've mentioned UOS a few times before here at the Motley Fool, and believe it is undervalued. The company's price/book ratio, which compares the current price to the net value of its assets is 0.4. In other words, the company is trading at less than half its book value. Perhaps it's the complexity that investors don't like, with the company owning investment properties in Malaysia through a 66% owned subsidiary. You can read more about UOS here and here.

AMA Group Limited (ASX: AMA) trades on a current P/E of 4.2 with a dividend yield of 7.4%. The company provides automotive repair services, vehicle protection equipment (bullbars) and sale of automotive accessories, and is current priced at around 13.5 cents. In the last two years the company has generated $13m in free cash flows and reported profits of $14.8m, yet the current market cap is just $38m. The company paid a dividend of 1 cent in 2011, its first since 2008. You can read more about AMA in this Motley Fool article.

TFS Corporation Limited (ASX: TFC) currently trades on a P/E of just under 5 and paid a dividend of 4.75 cents in 2011 which equates to a dividend yield of 11%. TFS is the owner and manager of Indian Sandalwood plantations in Western Australia. The company also has a direct holding in 340 hectares of Sandalwood in its own right. Before you think "Timbercorp clone", you should know that TFS operates the world's largest Indian Sandalwood plantation, and their timber product sells for an average price of over $100,000 per tonne. Managed Investment Schemes are a tax-advantaged investment vehicle, but as Timbercorp showed, investing only for tax reasons can be a very dangerous plan. Giving TFS investors some comfort, MIS sales to retail investors account for less than 5% of the company's total revenue.

With worldwide supplies diminishing, Sandalwood is becoming increasingly rare. Not only is the wood itself expensive, but one kilogram of Sandalwood oil sells for around $2,400. While this stock may be too risky and complex for some, it may be worthy of further research.

Regional Express Holdings Limited (ASX: REX) is currently trading on a P/E of 5.3 and paying a dividend yield of 6.7%. Yes, I know it's an airline, and I know what Warren Buffett thinks of them (hint: he's not very complimentary), and that was my first thought when I started looking at REX. The company is forecast to make a net profit after tax of around $25m in 2012, which equates to earnings per share of around 23 cents. And that is despite some fairly stiff headwinds, with the carbon tax, other tax and cost increases expected to add $6m to the expenses line of the profit & loss statement. Soaring fuel costs and falling passenger numbers are creating headaches for management as well. To top it all off, the company appears to have an image problem with complaints about axed and cancelled flights (here and here).

On the plus side, the company has very little debt with net debt of just $8.4m; has a monopoly business on many routes; is trading below its net tangible assets per share of $1.42 and directors hold around 26% of the company's shares. REX also has a number of strategies underway to increase its revenues and reduce costs, such as new airline routes and the sale of non-strategic assets.

Devine Limited (ASX: DVN) is currently trading on a P/E of 5.5, with a dividend yield of 9.9%. Another stock trading below its net tangible assets per share of $2.15, compared to its current share price of 63 cents. This property development company is one amongst many facing soft housing demand, but has stated that the medium to long term outlook is positive, with the supply of new housing falling well below demand. Devine expects to report a net profit for 2012 of around $14m.

The company is also undertaking a $1.4bn residential community at Gladstone, forecast to house 7,500 people over the next 12-15 years, which is underpinned by the massive LNG and resources projects currently under way in the area. The market obviously doesn't share that belief – and the market is often right. Of course, it's also often wrong, and that might mean an opportunity for investors prepared to do the legwork.

The Foolish bottom line

While not all low P/E stocks are worthy of investment, it can be a worthwhile hunting ground for under-valued stocks. It may take some time for the market to realise the true value of these stocks, or for the businesses to reach their full potential. In the meantime, you might be happy with the fairly high dividend yields each of the stocks above are offering.

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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article contains general investment advice only (under AFSL 400691).Authorised by Bruce Jackson.

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