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.
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. Compania Cervecerias Unidas S.A. ( CCU Quick Quote CCU - Free Report) , PVH Corp. ( PVH Quick Quote PVH - Free Report) , Concrete Pumping Holdings, Inc. ( BBCP Quick Quote BBCP - Free Report) , Ranger Energy Services, Inc. ( RNGR Quick Quote RNGR - Free Report) and ePlus inc. ( PLUS Quick Quote PLUS - Free Report) are some stocks with attractive EV-to-EBITDA ratios. EV-to-EBITDA is a Better Option, 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.
The other component of the multiple, EBITDA, gives a better idea of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows. Usually, the lower the EV-to-EBITDA ratio, the more appealing it is. A low EV-to-EBITDA ratio could indicate 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. P/E also can’t be used to value a loss-making firm. A firm’s earnings are also subject to accounting estimates and management manipulation. In contrast, EV-to-EBITDA is harder to manipulate and can be used to value companies with negative net earnings but are positive on the EBITDA front. EV-to-EBITDA is also a useful tool in measuring 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 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. Therefore, instead of just relying on EV-to-EBITDA, you can club it with the other major ratios, such as price-to-book (P/B), P/E and price-to-sales (P/S), to achieve the desired results. 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 50,000: 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 10 stocks that passed the screen: Compania Cervecerias Unidas is a multinational beverage company with diversified businesses and operations. This Zacks Rank #1 stock has a Value Score of B. You can see . the complete list of today’s Zacks #1 Rank stocks here Compania Cervecerias Unidas has an expected year-over-year earnings growth rate of 65.7% for the current year. The Zacks Consensus Estimate for CCU’s current-year earnings has been revised 13.7% upward over the past 60 days. PVH specializes in designing and marketing branded dress shirts, neckwear, sportswear, jeanswear, intimate apparel, swim products, footwear, handbags and related products. This Zacks Rank #2 stock has a Value Score of A. The Zacks Consensus Estimate for PVH’s current fiscal-year earnings has been revised 0.6% upward over the past 60 days. Its earnings beat the Zacks Consensus Estimate in each of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 23.4%, on average. Concrete Pumping Holdings is a leading provider of concrete pumping services and concrete waste management services in the United States and U.K. markets. This Zacks Rank #2 stock has a Value Score of A. Concrete Pumping Holdings has an expected year-over-year earnings growth rate of 43.2% for the current year. The Zacks Consensus Estimate for BBCP’s current-year earnings has been revised 15.2% upward over the past 60 days. Ranger Energy Services is a leading provider of high-specification mobile rig well services, cased hole wireline services, and ancillary services in the U.S. oil and gas industry. This Zacks Rank #2 stock has a Value Score of A. Ranger Energy Services has an expected year-over-year earnings growth rate of 192.1% for the current year. The Zacks Consensus Estimate for RNGR’s current-year earnings has been revised 8.2% upward over the past 60 days. ePlus inc. is a leading provider of technology solutions, enabling organizations to optimize their IT infrastructure and supply chain processes. This Zacks Rank #2 stock has a Value Score of B. ePlus has an expected year-over-year earnings growth rate of 7.7% for the current fiscal year. The Zacks Consensus Estimate for PLUS’ current fiscal-year earnings has been revised 6.8% 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