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.

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.

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

Young happy white woman loading groceries into the back of her car
Investing Articles

The FTSE 100 offers some great bargains. Is this one?

Our writer digs into one FTSE 100 share that has had a rough 2024 to date, ahead of its interim…

Read more »

Smiling white woman holding iPhone with Airpods in ear
Investing Articles

£9,000 of savings? Here’s my 3-step approach to aim for £1,794 in passive income

Christopher Ruane walks through the practical steps he would take to try and turn £9,000 into a sizeable passive income…

Read more »

Group of young friends toasting each other with beers in a pub
Investing Articles

I’d buy 29,412 shares of this UK dividend stock for £150 a month in passive income

Insiders have been buying this dividend stock, which offers an 8.5% yield. Roland Head explains why he’d choose the shares…

Read more »

Red briefcase with the words Budget HM Treasury embossed in gold
Investing Articles

Could the new UK budget spell growth for these 6 FTSE stocks? I think so!

Mark David Hartley considers six UK stocks that could enjoy growth off the back of new measures announced in the…

Read more »

Investing Articles

With a 6.6% yield, is now the right time to add this income stock to my ISA?

Our writer’s looking to boost his Stocks and Shares ISA. With this in mind, he’s debating whether to buy a…

Read more »

Dividend Shares

This blue-chip FTSE stock just fell 12.5% in a day. Is it time to consider buying?

Smith & Nephew is a well-known, blue-chip FTSE stock with a decent dividend yield. And its share price just dropped…

Read more »

Investing Articles

At 72p, the Vodafone share price looks to be at least 33% undervalued to me

Our writer looks at a number of valuation measures to determine whether the Vodafone share price reflects the fair value…

Read more »

Investing Articles

Why I’ve just sold two of the largest investments in my Stocks and Shares ISA

Stephen Wright has been making room for a new addition to his Stocks and Shares ISA. What is it and…

Read more »