The Highs, Lows and Middles of P/E-Based Investing

Now that you know the ins and outs of price-to-earnings ratios, how can you use P/Es to pick stocks?

That depends on whether your investing style is value, growth or the hybrid growth-at-a-reasonable-price, which is just a fancy way of saying you’ll pay up for stocks--to a point.

For value investors, Robert Gardiner, manager of the Wasatch Micro-Cap fund, recommends Travis Boats & Motors (ticker symbol: TRVS). He expects the boat maker’s profit to rise 40% this year and 25% annually over the next few years. The stock’s forward P/E, meanwhile, is only 19.6.

As the largest retailer of recreational boats in the country, Travis can “sell boats for less than many of its mom-and-pop competitors can buy them,” he said.

Boat makers can suffer in a weak economy but Travis actually grew during the last recession, Gardiner said. “Travis pretty much dictates the prices [it pays] to the boat manufacturers,” he added.

Gardiner also favors Usana Inc. (USNA), which makes nutritional products. One-third of its sales are in Canada and the company is making a big push to sell overseas. Earnings can grow 40% this year and 25% annually in coming years, Gardiner estimates, yet the stock’s forward P/E is only 15.4.

“They’re just one of those smaller companies that’s growing really fast,” he said.

Gardiner also likes First Cash (PAWN), which owns 64 pawn shops and manages seven others. Its forward P/E is 12 even though earnings could rise 22% this year, he said. The biggest name in the field, Cash America International (PWN), is growing at a slower pace but has a 30% higher P/E, Gardiner said.

First Cash is “growing faster and they have a lower P/E,” he said. “That’s what you want.”

Mark Toledo, chief investment officer at Mesirow Asset Management, suggests Brunswick (BC), which makes athletic and recreational gear. About 70% of its revenue comes from boats and related products but it hopes to boost sales of non-marine goods to 50%, Toldeo said. The boating business is cyclical while other athletic products, such as gear for bowling or fishing, are more stable.

Brunswick got new management three years ago and is a turnaround story, Toledo said, estimating that earnings can improve 13% this year and 15% next. The stock is trading around 14 times estimated 1998 earnings and 12 times the 1999 number, Toledo said.

Toledo is also high on Deere (DE), which makes agricultural and construction equipment. The agricultural economy is strong and farmers are buying more capital equipment, he said. Also, analysts are raising their earnings estimates, a positive sign. Earnings can grow 15% this year and 11% next year, Toledo said. The forward P/E is 13 for 1998.

Lowe’s Cos. (LOW), a large home-improvement retailer that hit a new high Monday, also is on Toledo’s list. It has more than 440 stores, mostly in the eastern U.S. The stock is priced at 28 times trailing earnings and profit is projected to rise 19% this fiscal year.

Home Depot (HD), by contrast, is expected to grow 25% this year but trades at a 42 P/E, a 50% premium to Lowe’s, Toledo said. The two companies compete directly in only one major market--Atlanta, he said.

For growth investors, Greg Kuhn of Kuhn Asset Management in Easton, Pa., likes Computer Horizons (CHRZ), a consulting company whose quarterly earnings growth rate has been rising sharply. After notching a 31% jump in the first quarter of 1997, the growth rate jumped to 73% in the second quarter and 130% in the third, he said. The fourth quarter showed a 100% improvement. The stock’s trailing P/E is 58.

Kuhn also owns Information Management Resources (IMRS), which does software consulting for large companies. Its sequential growth has also been strong, rising from 133% in the first quarter of last year to 280% in the fourth quarter, he said. With a trailing P/E of 88, “that stock could be trading at over 100 times earnings, no problem,” Kuhn said.

In the growth-at-a-reasonable-price camp, Marc Greenberg, a money manager at Avatar Associates, likes grocery chain Safeway (SWY), which trades at a trailing P/E of 29. The company, which owns the Vons chain, is cutting costs and has an efficient distribution system, Greenberg said.

Safeway is also improving its profit margins by selling more private-label products, which are high-end goods priced between those of brand names and supermarket generics.

Big supermarkets are consolidating by acquiring one another as well as small stores. That will drive Safeway’s earnings in coming years, Greenberg said. “You’re looking at a world that’s going to be radically different for supermarkets in 10 years,” he said.

Greenberg also recommends United Healthcare (UNH), which trades at 26 times trailing earnings. Stocks of health-maintenance organizations have been weak lately, in part because of pricing pressures created by the companies’ push for market share. But Greenberg thinks United Healthcare controls costs better than its competitors and can raise prices without losing customers.

“They all woke up one day and said, ‘Hey, wait a minute. Nobody’s making money. We’ve got to raise prices,’ ” he said.