Don’t Make These Basic Mistakes With BHP Billiton plc, Smith & Nephew plc And Tungsten Corp PLC

Watch out for P/E pitfalls with BHP Billiton plc (LON:BLT), Smith & Nephew plc (LON:SN) and Tungsten Corp PLC (LON:TUNG).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The price-to-earnings (P/E) ratio is undoubtedly the valuation measure most widely used by financial commentators and private investors. But there are P/E pitfalls that can lead you astray.

Three different mistakes to avoid can be illustrated by the cases of Smith & Nephew (LSE: SN), BHP Billiton (LSE: BLT) and Tungsten (LSE: TUNG).

Smith & Nephew

Medical devices firm Smith & Nephew headlines its results with an “adjusted” earnings-per-share (EPS) number. This excludes “exceptional” or “one-off” items. Most companies do this (analyst forecasts are also made on the same basis), and it’s the adjusted EPS number that typically becomes the “E” in our P/E calculations.

Should you invest £1,000 in Balfour Beatty Plc right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Balfour Beatty Plc made the list?

See the 6 stocks

Smith & Nephew reported adjusted EPS of 83.2¢ (about 53.7p) in its latest annual results, giving a P/E of 22 at a share price of 1,180p. However, if you look at those results, you’ll see that “restructuring & rationalisation costs” are one of the things the company excludes from its adjusted EPS. The trouble is that this “exceptional” item has appeared in Smith & Nephew’s results every year for the last 10 years bar one. It’s not really a one-off is it?

The $46m (5.2¢ per share) of costs the company reported this year is about average. If we treat these costs simply as a normal feature of the business, Smith & Nephew’s already high P/E of 22 (compared with 16.7 for the FTSE 100 as a whole) goes up even higher — to 23.5.

P/E pitfall: hidden recurring “one-offs” can lead your valuation astray.

BHP Billiton

If you look at BHP Billiton’s last annual results, you’ll find the company posted EPS of 252.7¢ (about 163p), giving a P/E of 9.8 at a share price of 1,600p. If you then go to the last annual results of Billiton’s big rival Rio Tinto, you’ll find Rio posted EPS of 503.4¢ (about 325p), giving a P/E of 9.7 at a share price of 3,150p.

Not much to choose between them, right? The trouble is Billiton has a 30 June financial year end, while Rio and all the other big Footsie miners have 31 December year ends. Rio’s P/E of 9.7 for the year ending 31 December 2014 is fine, but to compare Billiton on a meaningful basis, we need to take the latter’s EPS from the second half of its financial year ending 30 June 2014 and add it to the EPS for the first half of the year to 30 June 2015.

Doing the calculation produces EPS of 207.5¢ (about 134p), giving Billiton a P/E of 11.9. On a like-for-like basis, then, Billiton’s earnings rating is a good bit higher than Rio’s. You also need to go through a similar process of adjustment when calculating the two companies’ P/Es from analyst forecast earnings (although you may want to wait until the analysts have updated their forecasts after Billiton’s half-year results today.)

P/E pitfall: different company financial year ends can lead your comparative valuation astray.

Tungsten

Analyst earnings forecasts for the next two or three years are widely available on financial websites. Most of us look at forward P/Es — probably more so than trailing P/Es.

One often-overlooked point when using forward P/Es is illustrated by AIM-listed Tungsten. This company, which is a leading global B2B e-invoicing network, whose customers include Tesco, GlaxoSmithKline and Unilever, isn’t making a profit yet. However, the firm is forecast to deliver positive EPS in its financial year to 30 April 2017, giving a P/E of 12 at a share price of 170p.

But let’s remind ourselves of exactly what a P/E is. The number represents how many years it would take for EPS to total the share price we paid (if EPS stayed the same).

In Tungsten’s case, we have a P/E of 12, but if we invest today, it’s not 12 years (to 2027) for EPS to equal our share price. The company, remember, is not yet profitable, so the clock doesn’t start ticking until 2017. It would be 2029 for EPS to equal our share price — 14 years, and thus effectively putting Tungsten on a P/E of 14.

P/E pitfall: you could be paying a higher valuation than you may think when using forward earnings.

Of course, there are plenty of other passive income opportunities to explore. And these may be even more lucrative:

We think earning passive income has never been easier

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended shares in Glaxo, and owns shares in Tesco and Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

ISA Individual Savings Account
Investing Articles

Thinking of starting a Stocks and Shares ISA this April? Avoid these 4 mistakes!

A Stocks and Shares ISA can be a way for an investor to try and build wealth over the long…

Read more »

ISA coins
Investing Articles

Here’s how to build a £100k ISA starting with £5k today

Increase an ISA's value 20-fold? It need not just be the stuff of dreams, according to this writer -- though…

Read more »

A senior man and his wife holding hands walking up a hill on a footpath looking away from the camera at the view. The fishing village of Polperro is behind them.
Investing Articles

6.9% yield! I just added this share to my SIPP

In a turbulent stock market, our writer has been hunting for bargains to add to his SIPP. After a 31%…

Read more »

piggy bank, searching with binoculars
Investing Articles

With Rolls-Royce shares moving up again, is a £10 price target back on the horizon?

Rolls-Royce shares wobbled when President Trump dropped his tariff bombshell on us. But three weeks is a short time in…

Read more »

UK financial background: share prices and stock graph overlaid on an image of the Union Jack
Investing Articles

2 UK stocks to consider buying as the market sell-off continues

Stephen Wright thinks investors looking for opportunities might be able to take advantage of short-term weakness in some UK stocks.

Read more »

Closeup of "interest rates" text in a newspaper
Investing Articles

1 stock for passive income investors to consider buying before the Bank of England cuts interest rates

With the Bank of England’s Monetary Policy Committee set to meet in May, passive income investors should think about how…

Read more »

Tesla building with tesla logo and two teslas in front
Investing Articles

Is Tesla about to become the ultimate passive income machine?

Our writer discusses whether Tesla stock might be worth him buying, just in case the EV giant enables passive income…

Read more »

Rolls-Royce's Pearl 10X engine series
Investing Articles

Will the Rolls-Royce share price collapse? Here’s what the charts say

The Rolls-Royce share price has pulled back following the announcement of Donald Trump’s trade policy, but supportive trends remain.

Read more »