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5 Stocks Flaunting Enticing EV/EBITDA Ratios to Buy Now

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Price-to-earnings (P/E), given its apparent simplicity, is the most popular metric used by investors to work out the fair value of a stock. In fact, the idea of hunting stocks with a low P/E is ingrained in the minds of many value investors. But even this widely used equity valuation multiple suffers a few drawbacks.

What Makes EV/EBITDA a Better Alternative?

While P/E enjoys huge popularity among value inventors, a more complicated metric called EV/EBITDA does a better job. EV/EBITDA, also referred to as enterprise multiple, offers a clearer image of a firm’s valuation and its earnings potential. Unlike P/E that just considers a firm’s equity portion, EV/EBITDA determines its total value.

EV/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. Simply put, it is the total value of a firm.

EBITDA, the other element of the ratio, gives a true picture of a company’s profitability as it eliminates the impact of non-cash expenses like depreciation and amortization that depress net earnings.

Typically, the lower the EV/EBITDA ratio, the more appealing it is. A low EV/EBITDA ratio could imply that a stock is potentially undervalued.  

EV/EBITDA takes a more complete approach to valuation. It takes into account the debt on a company’s balance sheet that P/E ratio ignores. Due to this reason, EV/EBITDA is generally used to value potential acquisition targets as it shows the amount of debt the acquirer has to assume. Stocks with low EV/EBITDA multiple could be seen as enticing 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/EBITDA is less open to manipulation and can also be used to value companies that are making loss but are EBITDA-positive.

EV/EBITDA is also a useful yardstick in assessing the value of companies with high balance sheet leverage and considerable depreciation and amortization expenses. It also can be used to compare companies with different levels of debt.

However, EV/EBITDA is also not without its downsides. The ratio varies across industries and is generally not appropriate while comparing stocks in different industries given their diverse capital spending requirements.

Therefore, a strategy solely based on EV/EBITDA might not fetch the desired results.  But you can combine it with other key ratios 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 true value stocks:

EV/EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV/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.

Value Score of less than or equal to B: Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.

Here are five of the 11 stocks that passed the screen:

Cosan Limited is the leading global ethanol and sugar company in terms of production with low-cost, large-scale and integrated operations in Brazil. This Zacks Rank #1 stock has expected year-over-year earnings growth of 521.2% for 2017.

DST Systems, Inc. offers sophisticated information processing and computer software services and products that help clients improve productivity, increase efficiencies, and provide higher levels of customer service. This Zacks Rank #1 stock has an expected earnings per share (EPS) growth rate of 10% for 3 to 5 years. You can see the complete list of today’s Zacks #1 Rank stocks here.

Eastman Chemical Company (EMN - Free Report) is a global chemical company with a broad portfolio of chemical, plastic, and fiber products. This Zacks Rank #2 stock has an expected EPS growth rate of 7.9% for 3 to 5 years.

Fiat Chrysler Automobiles N.V. operates as an international automotive company and is engaged in designing, engineering, manufacturing, distributing and selling vehicles, components and production systems. This Zacks Rank #2 stock delivered an average positive earnings surprise of around 22.5% in the trailing four quarters.

Broadwind Energy, Inc. (BWEN - Free Report) owns, supports, grows and strategically positions companies that manufacture, install and maintain components for the energy industry, with a primary emphasis on the wind energy sector. This Zacks Rank #2 stock has expected year-over-year earnings growth of 400% for 2017.

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.

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