Price-to-earnings (P/E), given its inherent simplicity, is the most commonly used metric in the value investing world. It is preferred by many investors while handpicking stocks trading at attractive prices. However, even this straightforward, broadly-used valuation metric has a few limitations.
While P/E enjoys great popularity among value investors, a less-used and more-complicated metric called EV-to-EBITDA is sometimes viewed as a better alternative. EV-to-EBITDA gives the true picture of a company’s valuation and earnings potential. It has a more comprehensive approach to valuation. United Natural Foods, Inc. ( UNFI Quick Quote UNFI - Free Report) , PBF Energy Inc. ( PBF Quick Quote PBF - Free Report) , Plains GP Holdings, L.P. ( PAGP Quick Quote PAGP - Free Report) , ArcBest Corporation ( ARCB Quick Quote ARCB - Free Report) and SM Energy Company ( SM Quick Quote SM - Free Report) are some stocks with attractive EV-to-EBITDA ratios. EV/EBITDA is a Better Approach: Here’s Why
EV-to-EBITDA is essentially 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 constituent of the ratio, gives a clearer picture of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that dampen net earnings. It is also often used as a proxy for cash flows. Just like P/E, the lower the EV-to-EBITDA ratio, the more appealing it is. A low EV-to-EBITDA ratio could be a sign that a stock is potentially undervalued. EV-to-EBITDA takes into account the debt on a company’s balance sheet that the P/E ratio does not. Due to this reason, EV-to-EBITDA is generally used to value the potential acquisition targets as it shows the amount of debt the acquirer has to assume. Stocks boasting a low EV-to-EBITDA multiple could be seen as attractive takeover candidates. Another key downside of P/E is that it can’t be used to value a loss-making entity. Moreover, a company’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV-to-EBITDA is difficult to manipulate and can also be used to value companies incurring losses but are EBITDA-positive. EV-to-EBITDA is also a useful yardstick in 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 not devoid of shortcomings and it alone can’t conclusively determine a stock’s inherent potential and future performance. The multiple varies across industries and is usually not appropriate while comparing stocks in different industries, given their diverse capital expenditure requirements. As such, a strategy solely based on EV-to-EBITDA might not yield the desired results. But you can club it with the other major ratios in your stock-investing toolbox such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen value stocks. Screening Criteria
Here are the parameters to screen for value 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. 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. Value Score of less than or equal to B: Here are our five picks out of the 19 stocks that passed the screen: United Natural Foods is a leading distributor of natural, organic and specialty food and non-food products in the United States and Canada. This Zacks Rank #1 stock has a Value Score of A. United Natural Foods has an expected year-over-year earnings growth rate of 3.6% for the current fiscal year. UNFI’s earnings beat the Zacks Consensus Estimate in each of the trailing four quarters, the average being 29.9%. PBF Energy provides end products that comprise heating oil, transportation fuels, lubricants and many related products. 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 PBF Energy has an expected earnings growth rate of 383.6% for the current year. The Zacks Consensus Estimate for PBF's current-year earnings has been revised 34.5% upward over the past 60 days. Plains GP Holdings, through its subsidiaries, is involved in the transportation, storage, terminalling, and marketing of crude oil and refined products. This Zacks Rank #2 stock has a Value Score of A. Plains GP Holdings has an expected year-over-year earnings growth rate of 209.7% for the current year. The consensus estimate for PAGP's current-year earnings has been revised 29.7% upward over the past 60 days. ArcBest provides freight transportation services and solutions. This Zacks Rank #2 stock has a Value Score of A. ArcBest has an expected earnings growth rate of 58.9% for the current year. The Zacks Consensus Estimate for ARCB's current-year earnings has been revised 5.1% upward over the past 60 days. SM Energy is an independent oil and gas company engaged in the exploration, exploitation, development, acquisition and production of natural gas and crude oil in North America. This Zacks Rank #2 stock has a Value Score of A. SM Energy has an expected earnings growth rate of 387.6% for the current year. The Zacks Consensus Estimate for SM’s current-year earnings has been revised 7.1% 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. 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