Portfolio managers who beat the Street year after year appear to possess a divine power to predict the future -- particularly where stocks are heading. They are deemed prophets or oracles.
While TheStreet.com Ratings has neither divine powers nor a crystal ball, we do have a trove of parameters that enable us to make a highly educated estimate of what a stock's destiny may be.
Stocks with a low price-to-earnings (P/E) ratio can be considered undervalued. The same generally holds true for low price-to-book ratio (P/B), price-to-sales (P/S) and price-to-cash-flow (P/CF) ratios. The lower the ratio, the lower the risk that the shares may decline in price.
A low P/E ratio signifies a value stock -- it costs less to buy each dollar of earnings. The hope is that after buying a value stock on the cheap, the company's outlook will brighten and investors will value the stock closer to the market average.
Nasdaq Composite Index
is valued at nearly 36 times earnings. The blue-chip
S&P 500 Index
, which is frequently used as a benchmark for the market, has a P/E ratio of more than 17.
So, for example, an out-of-favor stock with a P/E of 10, whose outlook improves to match the market, could see its stock rise 70% on the same level of earnings.
Below are some exchange-traded funds with buy ratings from TheStreet.com Ratings, due to their superior total return performance and lower volatility.
Of the buy-rated ETFs, these have the lowest average P/E ratio or the lowest average P/B ratio. So these funds appear undervalued, yet their prices have trended higher.
The low P/E list is dominated by the very profitable energy industry. On the low P/B list, four of the five funds are either small-cap or micro-cap funds whose stocks tend be capitalized with a higher-than-average amount of equity, rather than being overloaded with debt.
On the flip side, stocks with high price ratios are already priced for perfection. High valuations usually accompany high growth rates. One bad quarter of earnings or one missed earnings estimate could disappoint the market. If investors believe that a company's growth rate cannot be sustained, they tend to punish the stock.
In the sell-rated funds below, the stock holdings have already begun to lag the performance of the market. On top of that, the high price ratios suggest that the holdings have room to fall. All of the ETFs on the high-P/E and high-P/B lists hold riskier technology stocks.
and HealthShares Patient Care
, with P/E ratios of 328.182 and 227.363 respectively, didn't make the list, because they are too new to have a rating. But average valuations that high are worth noting.
For more information on these funds, check out our
. Each report gives a description of the fund, breaks down the overall investment rating into risk and performance grades, and compares the fund with its peers.
Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by TheStreet.com, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.