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 a popular metric to work out the fair market value of a firm. But 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 earning 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. Daqo New Energy Corp. ( DQ Quick Quote DQ - Free Report) , TravelCenters of America Inc. ( TA Quick Quote TA - Free Report) , Covenant Logistics Group, Inc. ( CVLG Quick Quote CVLG - Free Report) , United Natural Foods, Inc. ( UNFI Quick Quote UNFI - Free Report) and Greif, Inc. ( GEF Quick Quote GEF - Free Report) are some stocks with attractive EV-to-EBITDA ratios. Is EV-to-EBITDA a Better Substitute to P/E?
Also referred to as enterprise multiple, 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 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. Unlike the P/E ratio, EV-to-EBITDA takes debt on a company’s balance sheet into account. For this reason, it is typically used to value potential acquisition targets. The ratio shows the amount of debt that the acquirer has to bear. Stocks flaunting a low EV-to-EBITDA multiple could be seen as attractive takeover candidates. Another shortcoming of P/E is that it 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-to-EBITDA is difficult to manipulate and can also be used to value companies making losses but are EBITDA-positive. EV-to-EBITDA is also a useful tool 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 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. 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 20 stocks that passed the screen: Daqo New Energy is a leading producer of high-purity polysilicon. This Zacks Rank #1 stock has a Value Score of A. Daqo New Energy has an expected earnings growth rate of 177.5% for the current year. The Zacks Consensus Estimate for DQ’s current-year earnings has been revised 6.4% upward over the past 60 days. TravelCenters of America is the largest publicly traded full-service travel center network in the United States. TA, flaunting a Zacks Rank #1, has a Value Score of A. You can see . the complete list of today’s Zacks #1 Rank stocks here TravelCenters of America has an expected year-over-year earnings growth of 96.6% for the current year. The consensus estimate for TA’s current-year earnings has been revised 128.2% upward over the last 60 days. Covenant Logistics, together with its subsidiaries, offers a portfolio of transportation and logistics services. CVLG, a Zacks Rank #1 stock, has a Value Score of A. Covenant Logistics has an expected year-over-year earnings growth rate of 50.4% for the current year. The Zacks Consensus Estimate for CVLG's current-year earnings has been revised 18.6% upward over the last 60 days. 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 #2 stock has a Value Score of A. United Natural Foods has an expected year-over-year earnings growth rate of 24% 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%. Greif is a leading global producer of industrial packaging products and services. This Zacks Rank #2 stock has a Value Score of A. Greif has an expected year-over-year earnings growth rate of 43% for the current fiscal year. The consensus estimate for GEF's current fiscal-year earnings has been revised 4.6% 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