4 Potentially High-Quality Stocks Trading at Less than 20 Times Forward Price-Earnings.

Most investors I know like to invest in stocks that will be around for a long time because they want to be more passive with their investments. They don’t like stocks that they need to monitor often and prefer the stocks that they can put in the work upfront and monitor to make sure that the business unfolds as they think it will.

There are mainly two approaches:

1. The Phillip Fisher Approach. This leads to companies with higher and more sustainable profitability or higher quality.
2. The Benjamin Graham Approach. The company is cheaper versus the perceived intrinsic value. The business tend to be valued based on more conservative cash flow.

Most prefer the Fisher Approach.

How do you achieve this?

If you don’t have the time, I would suggest you implement this philosophy through a systematically active fund/ETF in a more Strategic portfolio. Your portfolio has a long term allocation to the fund, does not change the allocation much but the fund strategy is active in a systematic kind of manner.

Some local or UCITS fund that allows you to express this philosophy is the GMO Quality Investment Fund, which can be purchased through Endowus. The others are the tickers IWQU, IUQA, DGRA, GGRA, MOAT, GOAT, SMOT, MOTU.

If that does not dissuade you, then you may be looking for quality companies that are at least trading at fair to low valuation relative to the valuation of their business quality.

Recently, I came across this Tweet that provide a list of quality companies trading below 20 times PE:

Stocks with 20%+ ROIC trading below 20x earnings

1. Alphabet $GOOGL:
ROIC: 25%
PE: 19x

2. Starbucks $SBUX:
ROIC: 25%
PE: 19x

3. Lululemon $LULU:
ROIC: 31%
PE: 17x

4. Paycom $PAYC
ROIC: 31%
PE: 19x

5. Booking Holdings $BKNG:
ROIC: 36%
PE: 18x

— Patient Investor (@patientinvestt) August 10, 2024

Patient Investor screens for stocks whose ROIC is above 20% but trades below 20 times PE. ROIC stands for return on invested capital and a company with high ROIC can be said to be a quality business. Invested Capital is an aggregate of the capital needed to operate the business and is a combination of long-term, short-term debt, preference shares, equity stake. The numerator is net profit or operating profit after tax. A company with consistently high ROIC means that they can generate a high return and not increase the capital put in at the same pace. A quality business can do that.

PE stands for price-earnings ratio and it is a ratio where we take the price per share, or the market capitalization of the business divide by the earnings per share or net income. A low price-earnings means the company is cheap.

If you wish to buy a quality business but don’t wish to overpay for it, then zooming in on these two metric will give you a good list to work with.

Paycom Software (PAYC)

Paycom is a provider of human resource software for small-medium-size firms.

If you had stayed invested for the six years before Paycom’s all-time high share price of $560, you would have made 3500%. Since the peak in 2021, the share price has come down almost 73%.

Mr Market seems to be punishing Paycom for its slow growth. They used to grow their revenue at 40% a year but have slowed down to a rate nearer to 20% a year. Competition, especially from A.I. products, has proved challenging in this small and medium-sized business space.

Stocks that may have hidden quality are usually cheaper, but not without reasons. Paycom may be cheap because Mr Market thinks they cannot go back to the previous high growth rate but more so, they can’t sustain their high gross margins (almost 80%) and their good ROIC.

I am not sure how Patient Investor arrived at a less than 20 times PE and I guess that is based on a forward EPS.

Here is the historical PE and the PE based on future earnings estimates:

PE Historical: 27

2024 Est: 23

2025 Est: 22

2026 Est: 19

PAYC is not cheap by our traditional standard but PAYC may have transition from growth stock to value stock.

It is quite useless if the good ROIC lasts one year. It might also be a good idea to review the PE relative to history. The table below tabulates the ROIC, net debt to capital, diluted EPS and average PE ratio for the past 11 years:

	ROIC (%)	Net Debt to Capital (%)	Diluted EPS	Avg PE Ratio (Last 12M E)
2013	4.8%	173%	-$0.12
2014	9.8%	23%	$0.11	153
2015	19.1%	Net Cash	$0.37	96
2016	52.5%	Net Cash	$1.21	34
2017	54.2%	Net Cash	$2.13	31
2018	39.8%	Net Cash	$2.37	49
2019	38.9%	Net Cash	$3.14	67
2020	23.1%	Net Cash	$2.49	124
2021	24.1%	Net Cash	$3.37	124
2022	25.6%	Net Cash	$4.84	67
2023	25.4%	Net Cash	$5.88	47

We notice that PAYC’s ROIC jumped to 54% before going down to 25%. As a company matures or has more competition from upstarts, we start seeing that more resources have to be diverted to remain competitive, and that affects the ROIC.

I wonder that if ROIC can drop this way, at this rate, does that mean that the business does not have such a moat at all? I guess it is likely this happens to most businesses as we have more businesses with less competitive advantage than more.

But it is also likely a company can maintain a certain ROIC over time which will show its quality.

PAYC has been net cash for a while, which may appeal to those of you who are looking for a company with no debt.

While their growth rate has slow down, we can see that EPS have been growing over time.

PAYC’s historical PE of 27 times actually places them at the low end of historical valuations.

Starbucks (SBUX)

Starbucks needs no introduction. If you are unfamiliar with Starbucks, you are either not a coffee drinker or living in a rural place.

I have covered Starbucks in my post about always having something that is attractive to buy.

Here is Starbucks valuation based on historical earnings and earnings estimates going forward:

PE Historical: 21

2024 Est: 21

2025 Est: 19

2026 Est: 17

Analyst and the company management is not expecting SBUX to grow their earnings much next year but more going forward.

The table below tabulates the ROIC, net debt to capital, diluted EPS and average PE ratio for the past 11 years:

	ROIC (%)	Net Debt to Capital (%)	Diluted EPS	Avg PE Ratio (Last 12M E)
2013	–	Net Cash	$0.01	–
2014	27.1%	6%	$1.37	28
2015	29.6%	12%	$1.84	26
2016	28.3%	20%	$1.92	30
2017	26.8%	21%	$1.99	29
2018	29.0%	32%	$3.27	17
2019	36.5%	312%	$2.94	26
2020	10.0%	91%	$0.79	101
2021	20.0%	75%	$3.57	30
2022	20.0%	97%	$2.85	32
2023	26.0%	85%	$3.60	28

SBUX mostly have higher than 20% ROIC except for the COVID year, but depending on the kind of investor you are, you might not like how its net debt to capital have balloon since 2018. I suspect that is partly due to management borrowing to buy back their shares.

SBUX’s historical PE of 21 times places it at the low end of its historical valuation.

Booking Holdings (BKNG)

I call Booking Holdings the largest online travel agency in the world. When we need to find air tickets and hotels, one of the sites we go to is Booking Holdings. BKNG manages to build out a set of complementary online sites through a series of acquisitions.

The sites under BKNG are more well known in Europe while the sites by their competitor Expedia are more well known in the United States.

BKNG have some nice growth drivers going for it, including growing middle-class incomes, purchasing power, a desire to travel and experience from developed countries. They have a very profitable business model, high margins, high free cash flow and low amounts of stock-based compensation.

BKNG beat their Q2 2024 revenue and earnings target but guided slower forward revenue growth.

Here is BKNG’s valuation based on historical earnings and earnings estimates going forward:

PE Historical: 22.6

2024 Est: 19

2025 Est: 17

2026 Est: 14.5

I notice that the estimated PE is lower, indicating that most expect BKNG’s earnings to grow, just at what rate.

The table below tabulates the ROIC, net debt to capital, diluted EPS and average PE ratio for the past 11 years:

	ROIC (%)	Net Debt to Capital (%)	Diluted EPS	Avg PE Ratio (Last 12M E)
2013	28%	12%	$36.10	24
2014	23%	10%	$45.67	26
2015	19%	33%	$49.45	24
2016	19%	31%	$42.65	31
2017	13%	33%	$46.86	38
2018	23%	25%	$83.26	23
2019	27%	9%	$111.82	17
2020	0%	6%	$1.43	1210
2021	11%	Net Cash	$28.17	80
2022	24%	1%	$76.35	27
2023	33%	6%	$117.41	24

Some of BKNG’s ROIC is above 20%, but there are some years where ROIC dropped below that. 2020 and 2021 were interesting because COVID significantly impacted global travel, and their financial results show that. COVID was probably a black swan event for BKNG, and we can look at how they bounced back as evidence of their business resilience and quality.

They always have some debt on their balance sheet but we can see that they do manage their debt well and I was surprised that even after COVID, their net debt to capital is still very low!

It took three years for BKNG to restore the EPS they last seen in 2019.

BKNG’s historical PE now places the company at the very low end of its historical valuations in the last ten years.

Alphabet (GOOG)

Alphabet is also a stock that needs no introduction. GOOG happened to be the stock with the lacklustre Q2 2024 financial results (along with Amazon), so their share price has been duly punished. A worry over how A.I. applications will impact search in the future is a constant overhang that keeps the share price in check, but if that is not a big enough problem, you own a set of very competitive information technology businesses.

Here is Alphabet’s valuation based on historical earnings and earnings estimates going forward:

PE Historical: 28

2024 Est: 22

2025 Est: 20

2026 Est: 16

Alphabet’s PE is below 20, most likely based on forward earnings estimates, and forward estimates are projections guided by the company, perhaps adjusted by analyst consensus estimates. And earnings are project to grow higher just how much higher.

The table below tabulates the ROIC, net debt to capital, diluted EPS and average PE ratio for the past 11 years:

	ROIC (%)	Net Debt to Capital (%)	Diluted EPS	Avg PE Ratio (Last 12M E)
2013	15%	Net Cash	$0.94
2014	13%	Net Cash	$1.03	26
2015	14%	Net Cash	$1.18	25
2016	14%	Net Cash	$1.39	26
2017	9%	Net Cash	$0.9	50
2018	17%	Net Cash	$2.19	25
2019	16%	Net Cash	$2.46	24
2020	15%	Net Cash	$2.93	25
2021	25%	Net Cash	$5.61	22
2022	22%	Net Cash	$4.56	25
2023	24%	Net Cash	$5.80	20

Since COVID, Alphabet has shown stronger ROIC. Before that, the ROIC hovers around 15%. Most would know that Alphabet has a stronger ROIC closer to 30% and the difference is how do you calculate invested capital. Alphabet’s growth in EPS has been bonkers especially from 2016/17 to 2018 and 2020 to 2021.

With a current historical PE of 28 times, this is not too cheap relative to the average PE that Alphabet trades at because they have always trade around a PE like this historically.

Last Word

I think this should make a pretty short but good list of companies with the recent correction in share prices. You may be more interested in hunting for the companies that have corrected due to sentiments but generally have wide economic moats.

The stocks that you disagree with Mr Market on the longer-term earnings may also be what you should be looking for.

Generally, good stocks drop for a certain reasons. If everyone seem to know that they don’t have issues and are great, then their share prices should not drop. A high quality company can work through those problems and mitigate those problems now and in the future so the question is whether these businesses could or this IS the point where the business goes to shit.

I was introduced to Paycom through this list, and it surprised me that I would have at least a 5% earnings yield (an invert of PE) going forward. I will pay some attention to it.

Booking Holdings look like a company that I would look more into.

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