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 a bargain. However, even this straightforward, broadly used valuation metric 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. JinkoSolar Holding Co., Ltd. ( JKS Quick Quote JKS - Free Report) , PVH Corp. ( PVH Quick Quote PVH - Free Report) , Titan Machinery Inc. ( TITN Quick Quote TITN - Free Report) , ADT Inc. ( ADT Quick Quote ADT - Free Report) and Park Hotels & Resorts Inc. ( PK Quick Quote PK - Free Report) are some stocks with attractive EV-to-EBITDA ratios. EV-to-EBITDA is a Better Option, Here’s Why
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 element of the ratio, gives a clearer picture of a company’s profitability as it strips out non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows. Generally, the lower the EV-to-EBITDA ratio, the more enticing it is. A low EV-to-EBITDA ratio could indicate 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. Moreover, P/E 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 that have 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 also not without its shortcomings and alone cannot 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. As such, 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 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 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 eight stocks that passed the screen: JinkoSolar is one of the leading solar module manufacturers, which distributes its solar products to a diversified international utility, commercial and residential customer base globally. This Zacks Rank #1 stock has a Value Score of A. JinkoSolar has an expected year-over-year earnings growth rate of 108.6% for the current year. JKS’ earnings beat the Zacks Consensus Estimate in each of the last four quarters at an average of 102.7%. 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. You can see . the complete list of today’s Zacks #1 Rank stocks here PVH has an expected year-over-year earnings growth rate of 15.3% for the current fiscal year. PVH’s earnings beat the Zacks Consensus Estimate in each of the last four quarters at an average of 22.8%. Titan Machinery operates a network of full-service agricultural and construction equipment dealer locations in North America and Europe. This Zacks Rank #2 stock has a Value Score of A. Titan Machinery has an expected year-over-year earnings growth rate of 11.9% for the current fiscal year. TITN’s earnings beat the Zacks Consensus Estimate in three of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 18.5%, on average. ADT provides security and automation solutions for homes and businesses, primarily in the United States and Canada. This Zacks Rank #2 stock has a Value Score of A. ADT has an expected year-over-year earnings growth rate of 58.3% for the current year. The Zacks Consensus Estimate for ADT’s current fiscal-year earnings has been revised 5.5% upward over the last 60 days. Park Hotels & Resorts is a leading publicly-traded lodging REIT with a diverse portfolio of iconic and market-leading hotels and resorts. This Zacks Rank #2 stock has a Value Score of A. Park Hotels & Resorts has an expected year-over-year earnings growth rate of 28.6% for the current year. PK’s earnings beat the Zacks Consensus Estimate in three of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 12.3%, on average. 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