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Pick These 5 Bargain Stocks with Impressive EV/EBITDA Ratios
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Investors typically have a fixation for the price-to-earnings (P/E) strategy in their quest for stocks that are trading at a bargain. A widely favored approach by value investors is to chase stocks that have a low P/E ratio. But even this straightforward, broadly used valuation metric is not devoid of limitations.
What Makes EV/EBITDA a Better Substitute?
While P/E enjoys significant popularity in the value investing world given its apparent simplicity, a more complicated metric called EV/EBITDA works even better. The ratio is often viewed as a better alternative to P/E as it offers a clearer image of a company’s valuation and its earnings potential. EV/EBITDA, also referred to as enterprise multiple, has a more complete approach to valuation as it determines the total value of a firm as opposed to P/E, which considers only its equity portion.
EV/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 a nutshell, it is the entire value of a company.
The other component, EBITDA gives the true picture of a firm’s profitability as it eliminates the impact of non-cash expenses like depreciation and amortization that dilute net earnings.
Usually, the lower the EV/EBITDA ratio, the more attractive it is. A low EV/EBITDA ratio could imply that a stock is potentially 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, EV/EBITDA is usually used to value possible acquisition targets. It shows the amount of debt the acquirer has to bear. Stocks with a low EV/EBITDA multiple could be seen as attractive takeover candidates.
P/E also can’t be used to value a loss-making firm. A company’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV/EBITDA is difficult to manipulate and can also be used to value companies that are making loss but are EBITDA-positive.
Moreover, EV/EBITDA allows the comparison of companies with different debt levels and is a useful tool in measuring the value of firms that are highly leveraged and have substantial depreciation and amortization expenses.
However, EV/EBITDA is not without its limitations and it alone can’t 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, a strategy only based on EV/EBITDA might not fetch the desired outcome. But you can combine it with other major ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen bargain 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 Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are five of the 19 stocks that passed the screen:
Huntsman Corporation (HUN - Free Report) is among the world's leading global manufacturers of differentiated and commodity chemical products for a variety of industrial and consumer applications. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 41.9% for 2018 and a Value Score of A.
Matson, Inc. (MATX - Free Report) operates as an ocean transportation and logistics company. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 31.5% for 2018 and a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
GMS Inc. (GMS - Free Report) is a distributor of wallboard and suspended ceilings systems. The stock has an expected year-over-year earnings growth rate of 65.2% for fiscal 2019. It currently has a Value Score of A and a Zacks Rank #1.
Covenant Transportation Group, Inc. is a truckload carrier that offers just-in-time and other premium transportation services throughout the United States. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 153.6% for 2018 and a Value Score of A.
Domtar Corporation is a leading provider of a wide variety of fiber-based products including communication, specialty and packaging papers, market pulp and absorbent hygiene products. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 48.5% for 2018. It also has a Value Score of A.
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.
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.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »
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Pick These 5 Bargain Stocks with Impressive EV/EBITDA Ratios
Investors typically have a fixation for the price-to-earnings (P/E) strategy in their quest for stocks that are trading at a bargain. A widely favored approach by value investors is to chase stocks that have a low P/E ratio. But even this straightforward, broadly used valuation metric is not devoid of limitations.
What Makes EV/EBITDA a Better Substitute?
While P/E enjoys significant popularity in the value investing world given its apparent simplicity, a more complicated metric called EV/EBITDA works even better. The ratio is often viewed as a better alternative to P/E as it offers a clearer image of a company’s valuation and its earnings potential. EV/EBITDA, also referred to as enterprise multiple, has a more complete approach to valuation as it determines the total value of a firm as opposed to P/E, which considers only its equity portion.
EV/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 a nutshell, it is the entire value of a company.
The other component, EBITDA gives the true picture of a firm’s profitability as it eliminates the impact of non-cash expenses like depreciation and amortization that dilute net earnings.
Usually, the lower the EV/EBITDA ratio, the more attractive it is. A low EV/EBITDA ratio could imply that a stock is potentially 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, EV/EBITDA is usually used to value possible acquisition targets. It shows the amount of debt the acquirer has to bear. Stocks with a low EV/EBITDA multiple could be seen as attractive takeover candidates.
P/E also can’t be used to value a loss-making firm. A company’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV/EBITDA is difficult to manipulate and can also be used to value companies that are making loss but are EBITDA-positive.
Moreover, EV/EBITDA allows the comparison of companies with different debt levels and is a useful tool in measuring the value of firms that are highly leveraged and have substantial depreciation and amortization expenses.
However, EV/EBITDA is not without its limitations and it alone can’t 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, a strategy only based on EV/EBITDA might not fetch the desired outcome. But you can combine it with other major ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen bargain 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 Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are five of the 19 stocks that passed the screen:
Huntsman Corporation (HUN - Free Report) is among the world's leading global manufacturers of differentiated and commodity chemical products for a variety of industrial and consumer applications. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 41.9% for 2018 and a Value Score of A.
Matson, Inc. (MATX - Free Report) operates as an ocean transportation and logistics company. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 31.5% for 2018 and a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
GMS Inc. (GMS - Free Report) is a distributor of wallboard and suspended ceilings systems. The stock has an expected year-over-year earnings growth rate of 65.2% for fiscal 2019. It currently has a Value Score of A and a Zacks Rank #1.
Covenant Transportation Group, Inc. is a truckload carrier that offers just-in-time and other premium transportation services throughout the United States. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 153.6% for 2018 and a Value Score of A.
Domtar Corporation is a leading provider of a wide variety of fiber-based products including communication, specialty and packaging papers, market pulp and absorbent hygiene products. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 48.5% for 2018. It also has a Value Score of A.
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.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »