Generally, investors look for stocks with a low price-to-earnings (P/E) ratio. The idea is that the lower the P/E, the higher will be the value of a stock. It means a stock’s current market price is yet to be priced in, and has room for growth owing to its higher earnings potential. This clearly indicates investors’ inclination toward low P/E stocks.
But stocks with a rising P/E are also worth a bet. We’ll tell you why.
Why Rising P/E a Valuable Tool?
Investors should note that stock price moves in tandem with earnings performance. If earnings come in stronger, the price of a stock shoots up. Solid quarterly earnings and the forward guidance boost earnings forecasts, leading to stronger demand for the stock and a rise in price.
So, if the price is rising steadily, it means that investors are assured of the stock’s fundamental strength and expect some strong positives out of it. Suppose an investor wants to buy a stock with a P/E ratio of 30, it means that he is willing to shell out $30 for only $1 worth of earnings. This is because the investor expects earnings of the company to rise at a faster pace in the future on the back of strong fundamentals.
Also, studies have revealed that stocks have seen their P/E ratios jump more than 100% from their breakout point in the cycle. So, if you can pick stocks early in their breakout cycle, you can end up seeing considerable gains.
The Winning Strategy
In order to shortlist stocks that are exhibiting an increasing P/E, we chose the following as our primary screening parameters.
EPS growth estimate for the current year is greater than or equal to last year’s actual growth Percentage change in last year EPS should be greater than or equal to the previous year
(These two criteria point to a positive or flat earnings growth trend over the years).
Percentage change in price over four weeks greater than percentage change in price over 12 weeks Percentage change in price over 12 weeks greater than percentage change in price over 24 weeks
(These two criteria show that price of the stock is increasing consistently over the said timeframes).
Percentage price change for four weeks relative to the S&P 500 greater than percentage price change for 12 weeks relative to the S&P 500 Percentage price change for 12 weeks relative to the S&P 500 greater than percentage price change for 24 weeks relative to the S&P 500
(Here the case for consistent price gains gets even stronger as it displays percentage price changes relative to the S&P 500).
Percentage price change for 12 weeks is 20% higher than or equal to percentage price change for 24 weeks, but it should not exceed 100%
(This criterion indicates that a 20% increase in the price of a stock from the breakout point gives cues of an impending uptrend. But a jump of over 100% indicates that there is limited scope for further upside and the stock might be due for a reversal).
In addition, we place a few other criteria that lead us to some likely outperformers.
Zacks Rank less than or equal to 2: Only companies with a Strong Buy or Buy rating can get through. Average 20-day Volume greater than or equal to 50,000: High trading volume implies that the stocks have adequate liquidity.
Just these few criteria narrowed down the universe from over 7,700 stocks to just nine.
Here are five of the nine stocks that passed the screen.
Immersion Corporation ( IMMR Quick Quote IMMR - Free Report) : The company develops hardware and software technologies that enable users to interact with computers using their sense of touch. The stock has a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here. Semtech Corporation (This Zacks Rank #2 company designs, manufactures and markets a wide range of analog and mixed- signal semiconductors for commercial applications. SMTC Quick Quote SMTC - Free Report) : The New York Times Company (It operates as a diversified media company that comprises newspapers, Internet businesses and other investments. The stock has a Zacks Rank #2. NYT Quick Quote NYT - Free Report) : Flux Power Holdings Inc. (The Zacks Rank #2 company designs, develops and sells rechargeable energy storage systems. FLUX Quick Quote FLUX - Free Report) : Chewy Inc. ( The Zacks Rank #2 company operates as an online pet retailer. The company offers pet products which include dry and wet food, toys, mats, biscuits, vitamins and supplements. CHWY Quick Quote CHWY - Free Report) :
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. 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.