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5 Bargain Stocks with Enticing EV/EBITDA Ratios to Own Now

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Price-to-earnings (P/E) is hands down the most popular metric used by investors to handpick undervalued stocks. The idea of chasing stocks with a low P/E is ingrained in the minds of many value investors. But even this ubiquitously used valuation metric is not without its drawbacks.

EV/EBITDA is a Better Approach, But Why?

While P/E enjoys great popularity in the value investing world, a less used and more complicated metric called EV/EBITDA gains an upper hand as it offers a clearer picture of a company’s valuation and earnings potential. EV/EBITDA, also known as the enterprise multiple, has a more complete approach to valuation as it determines a firm’s total value. P/E, on the other hand, considers only its equity portion.

EV/EBITDA, in essence, 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.

EBITDA, the other element of the ratio, is a true reflection of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that dilute net earnings.

Just like P/E, the lower the EV/EBITDA ratio, the more enticing it is. A low EV/EBITDA ratio could be a sign that a stock is undervalued and vice versa.

EV/EBITDA also takes into account the debt on a company’s balance sheet that P/E ratio ignores. For this reason, it is typically used to value potential acquisition targets. EV/EBITDA shows the amount of debt the acquirer has to bear. Stocks with a low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another key drawback of P/E is that it can’t be used to value a loss-making entity. A firm’s earnings are also subject to accounting estimates and management manipulation. On the contrary, EV/EBITDA is less amenable to manipulation and can also be used to value companies that have negative net earnings but are positive on the EBITDA front.

EV/EBITDA is also a useful yardstick in evaluating the value of companies that are highly leveraged and have a high degree of depreciation. It also can be used to compare companies with different levels of debt.

However, EV/EBITDA is also not without its downsides 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.

As such, a strategy solely based on EV/EBITDA might not fetch the desired outcome. But you can combine it with the other major ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen true value stocks.
 
Screening Criteria

Here are the parameters to screen for bargain stocks:

EV/EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV/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 Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.

Here are five of the 12 stocks that passed the screen:

SORL Auto Parts, Inc. specializes in the development, production and distribution of air brake valves and hydraulic brake valves. This Zacks Rank #1 stock delivered an average positive earnings surprise of 94.5% in the trailing four quarters.

Tenet Healthcare Corp. (THC - Free Report) is an investor-owned health care services company that owns or operates general hospitals and related health care facilities, serving urban and rural communities in numerous states. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 15.9% for 2017. You can see the complete list of today’s Zacks #1 Rank stocks here.

Office Depot, Inc. (ODP - Free Report) is a leading global provider of products, services, and solutions for every workplace. This Zacks Rank #2 stock has an expected earnings per share (EPS) growth rate of 10.9% for three to five years.

Hilltop Holdings Inc. (HTH - Free Report) is a diversified financial holding company, specializing in banking, mortgage origination, financial advisory and insurance. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 9.8% for 2017.

Regal Beloit Corporation (RBC - Free Report) is a leading manufacturer of electrical and mechanical motion control and power generation products serving markets throughout the world. This Zacks Rank #2 stock has an expected EPS growth rate of 9% for three to five years.

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.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

Click here to sign up for a free trial to the Research Wizard today.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.

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