The price-to-earnings (P/E) multiple enjoys wide-scale popularity among investors seeking stocks trading at a bargain. In addition to being a widely-used tool for screening stocks, P/E is also a popular metric to work out the fair market value of a firm. However, even this ubiquitously used valuation multiple has a few downsides.
Although P/E is the most popular valuation metric, a more complicated multiple called EV-to-EBITDA works even better. Often considered a better alternative to P/E, it gives the true picture of a company’s valuation and earnings potential, and has a more complete approach to valuation. While P/E considers a firm’s equity portion, EV-to-EBITDA determines its total value.
Greif, Inc. GEF, UFP Industries, Inc. UFPI, SpartanNash Company SPTN, United Microelectronics Corporation UMC and AXIS Capital Holdings Limited AXS are some stocks with attractive EV-to-EBITDA ratios.
What Makes EV-to-EBITDA a Better Alternative?
EV-to-EBITDA is the enterprise value (EV) of a stock divided by its earnings before interest, taxes, depreciation and amortization (EBITDA). EV is the sum of a company’s market capitalization, its debt and preferred stock minus cash and cash equivalents. In essence, it is the entire value of a company.
EBITDA, the other element of the ratio, gives a clearer picture of a company’s profitability as it strips out non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows.
Usually, the lower the EV-to-EBITDA ratio, the more attractive it is. A low EV-to-EBITDA ratio could signal that a stock is potentially undervalued.
However, unlike P/E ratio, EV-to-EBITDA takes into account the debt on a company’s balance sheet. Given this reason, EV-to-EBITDA is usually used to value the possible acquisition targets. Stocks with a low EV-to-EBITDA multiple could be seen as potential takeover candidates.
Moreover, P/E can’t be used to value a loss-making firm. A firm’s earnings are also subject to accounting estimates and management manipulation. In contrast, EV-to-EBITDA is harder to manipulate and can also be used to value companies that have negative net earnings but are positive on the EBITDA front.
EV-to-EBITDA is also a useful tool for evaluating the value of firms that are highly leveraged and have a high degree of depreciation. Moreover, it can be used to compare companies with different levels of debt.
However, EV-to-EBITDA is also not without its shortcomings and alone cannot conclusively determine a stock’s inherent potential and future performance. The ratio varies across industries and is generally not appropriate while comparing stocks in different industries given their diverse capital spending requirements.
Thus, instead of solely banking on EV-to-EBITDA, you can club it with other key ratios in your stock investment toolkit such as price-to-book (P/B), P/E and price-to-sales (P/S) to uncover bargain stocks.
Here are the parameters to screen for bargain stocks:
EV-to-EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV-to-EBITDA ratio represents a cheaper valuation.
P/E using (F1) less than X-Industry Median: This metric screens stocks that are trading at a discount to their peers.
P/B less than X-Industry Median: A lower P/B compared with the industry average implies that the stock is undervalued.
P/S less than X-Industry Median: The lower the P/S ratio, the more attractive the stock is, as investors will have to pay a smaller price for the same amount of sales generated by the company.
Estimated One-Year EPS Growth F(1)/F(0) greater than or equal to X-Industry Median: This parameter will help in screening stocks that have growth rates higher than the industry median. This is a meaningful indicator as decent earnings growth always adds to investor optimism.
Average 20-day Volume greater than or equal to 100,000: The addition of this metric ensures that shares can be traded easily.
Current Price greater than or equal to $5: This parameter will help in screening stocks that are trading at a minimum price of $5 or higher.
Zacks Rank less than or equal to 2: No screening is complete without the Zacks Rank, which has proven its worth since inception. It is a fundamental truth that stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have always managed to beat adversities and outperform the market.
Value Score of less than or equal to B: Our research shows that stocks with a Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are our five picks out of the 19 stocks that passed the screen:
Greif is a leading global producer of industrial packaging products and services. This Zacks Rank #1 stock has a Value Score of A.
Greif has an expected year-over-year earnings growth rate of 36.3% for the current fiscal year. The Zacks Consensus Estimate for GEF’s current fiscal-year earnings has been revised 17.4% upward over the past 60 days.
UFP Industries supplies wood, wood composite and other products in retail, industrial, and construction markets. This Zacks Rank #1 stock has a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
UFP Industries has an expected earnings growth rate of 11.8% for the current year. The Zacks Consensus Estimate for UFPI’s current-year earnings has been revised 16.1% upward over the past 60 days.
SpartanNash distributes grocery products to a diverse group of independent and chain retailers, its corporate-owned retail stores, and U.S. military commissaries and exchanges. This Zacks Rank #1 stock has a Value Score of A.
SpartanNash has an expected earnings growth rate of 32.9% for the current year. The Zacks Consensus Estimate for SPTN’s current-year earnings has been revised 6.6% upward over the past 60 days.
United Microelectronics is a leading semiconductor foundry company, providing high-quality integrated circuit production with a focus on logic and specialty technologies to cater to every major sector of the electronics industry. This Zacks Rank #2 stock has a Value Score of A.
United Microelectronics has an expected earnings growth rate of 51.8% for the current year. The Zacks Consensus Estimate for UMC’s current-year earnings has been revised 12.5% upward over the past 60 days.
AXIS Capital Holdings provides a broad range of specialty insurance and reinsurance solutions to its clients globally. This Zacks Rank #2 stock has a Value Score of A.
AXIS Capital Holdings has an expected earnings growth rate of 23.6% for the current year. The Zacks Consensus Estimate for AXS’s current-year earnings has been revised 18.3% upward over the past 60 days.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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