Standing out among the Street's worst performers today is VALE S.A., an industrial metals & mining company whose shares slumped -4.5% to a price of $13.68, 19.91% below its average analyst target price of $17.08.
The average analyst rating for the stock is buy. VALE underperformed the S&P 500 index by -5.1% during today's morning session, but outpaced it by 20.9% over the last year with a return of 3.1%.
Vale S.A., together with its subsidiaries, produces and sells iron ore and iron ore pellets for use as raw materials in steelmaking in Brazil and internationally. The company belongs to the basic materials sector, which includes the chemical, coal, mining, aluminum, and steel industries. The demand for these materials is dependent on economic cycles: when the economy is growing, companies across all sectors ramp up production, which increases demand from basic materials companies.
Conversely, when the economy slows down, demand for these materials decreases. The stock prices of this sector tend to follow the ebbs and flows of these demand cycles -- but accurately predicting where we are presently in the economic cycle is a matter of intense debate.
VALE S.A.'s trailing 12 month P/E ratio is 3.4, based on its trailing Eps of $4.01. The company has a forward P/E ratio of 5.5 according to its forward Eps of $2.5 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US basic materials companies is 8.57, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
A significant limitation with the price to earnings analysis is that it doesn’t account for investors’ growth expectations in the company. For example, a company with a low P/E ratio may not actually be a good value if it has little growth potential. Conversely, companies with high P/E ratios may be fairly valued in terms of growth expectations.
When we divide VALE's P/E ratio by its projected 5 year earnings growth rate, we see that it has a Price to Earnings Growth (PEG) ratio of -0.22. This tells us that the company is largely undervalued in terms of growth expectations -- but remember, these growth expectations could turn out to be wrong!
To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on VALE's margins:
- 2021 gross margins: 60.0 %
- 2020 gross margins: 55.9 %
- 2019 gross margins: 47.2 %
- 2018 gross margins: 39.6 %
- Average gross margin: 50.7 %
- Average gross margin growth rate: 15.0 %
- Coefficient of variability (higher numbers indicating more instability): 18.0 %
We can see from the above that VALE S.A.'s gross margins are very strong. Potential investors in the stock will want to determine what factors, if any, could derail this attractive growth story.
Companies have many costs that arise independently from their core business: cost of maintaining debt, rent payments, capital expenditures, depreciation, etc. When all of these separate cash flows are taken into account, we are left with the company's free cash flow, which for VALE S.A. was $109,465,000,000.00 as of its last annual report.
This represents the amount of money that is available for reinvesting in the business, or for paying out to investors in the form of a dividend. With its strong cash flows, VALE is in a position to do either -- which can encourage more investors to place their capital in the company. Over the last four years, the company's free cash flow has been growing at a rate of 54.4% and has on average been $57,578,250,000.00.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts). Vale s.a.'s P/B ratio of 0.3 indicates that the market value of the company is less than the value of its assets -- a potential indicator of an undervalued stock. The average P/B ratio of the Basic Materials sector was 1.86 as of the third quarter of 2022.
Since it has a very low P/E ratio, an exceptionally low P/B ratio, and an irregular stream of positive cash flows with an upwards trend, VALE S.A. is likely undervalued at today's prices. The company has mixed growth indicators because of a negative PEG ratio and consistently strong gross margins that are increasing. We hope you enjoyed this overview of VALE's fundamentals. Be sure to check the numbers for yourself, especially focusing on their trends over the last few years.
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