Wall Street has seen a nice run this year, making many investors happy but nervous too. Nervous because after such a stupendous rally, thoughts of overvaluation are inevitable. Many investors are probably fervently looking for undervalued stocks now.
Agreed, this is an intriguing and age-old idea. But there are also other ways to ride out a lofty market. Investors commonly believe that lower the P/E, the higher will be the value of the stock. The logic is simple — a stock’s current market price is not reflective its higher earnings and therefore chances of outperformance are higher.
But there is more to this whole P/E story as not only low P/E, stocks with a rising P/E can prove worthwhile in finding great stocks. Let’s dig a little deeper.
Rising P/E: An Useful Tool
Generally, the price of a stock rallies on a rise in earnings. As forecasts for expected earnings move higher, demand for the stock should drive its price. After all, a stock's P/E gives an indication of how much investors are ready to shell out for every dollar of earnings. Thus, if the P/E of a stock is rising steadily, it means that investors are pinning their hopes on the company’s inherent strength.
Also, studies have revealed that stocks have seen their P/E ratios jump over 100% from their breakout point in the cycle. So, if you can pick stocks early in their breakout cycle, you can end up seeing considerable gains.
The Winning Strategy
In order to shortlist stocks that are exhibiting an increasing P/E, we chose the following as our primary screening parameters.
EPS growth estimate for the current year is greater than or equal to last year’s actual growth
Percentage change in last year EPS should be greater than or equal to zero
(These two criteria point to flat earnings or a growth trend over the years.)
Percentage change in price over four weeks greater than the percentage change in price over 12 weeks
Percentage change in price over 12 weeks greater than percentage change in price over 24 weeks
(These two criteria show that price of the stock is increasing consistently over the said timeframes.)
Percentage price change for four weeks relative to the S&P 500 greater than the percentage price change for 12 weeks relative to the S&P 500
Percentage price change for 12 weeks relative to the S&P 500 greater than the percentage price change for 24 weeks relative to the S&P 500
(Here, the case for consistent price gains gets even stronger as it displays percentage price changes relative to the S&P 500.)
Percentage price change for 12 weeks is 20% higher than or equal to the percentage price change for 24 weeks, but it should not exceed 100%
(A 20% increase in the price of a stock from the breakout point gives cues of an impending uptrend. But a jump of over 100% indicates that there is limited scope for further upside and that the stock might be due for a reversal.)
In addition, we place a few other criteria that lead us to some likely outperformers.
Zacks Rank less than or equal to 2: Only companies with a Zacks Rank #1 (Strong Buy) or 2 (Buy) can get through.
Average 20-day Volume greater than or equal to 50,000: High trading volume implies that the stocks have adequate liquidity.
Just these few criteria narrowed down the universe from over 7,700 stocks to just 19.
Here are five out of the 19 stocks:
MINDBODY Inc. (MB - Free Report) : This is a developer of cloud-based business management software and payments’ platform for the wellness services industry. The stock belongs to a Zacks Industry Rank in the top 39%. It carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Piedmont Office Realty Trust Inc. (PDM - Free Report) : This is an integrated and self-managed real estate investment trust, carrying a Zacks Rank #2. The stock belongs to a Zacks Industry Rank in the top 35%.
B&G Foods Inc. (BGS - Free Report) : This is a manufacturer and seller of a diversified portfolio of shelf-stable foods across the United States, Canada and Puerto Rico. The stock belongs to a Zacks Sector Rank in the top 41% and carries a Zacks Rank #2.
Macquarie Infrastructure Company (MIC - Free Report) : This operator and investor in a diversified group of infrastructure businesses belongs to a Zacks Industry Rank in the top 22%. The stock has a Zacks Rank #1 (Strong Buy).
Prestige Brand Holdings Inc. (PBH - Free Report) : This company is a marketer and distributor of brand name over- the-counter drug, personal care and household cleaning products sold throughout the United States and Canada. The Zacks Industry Rank is in the top 21%. The stock has a Zacks Rank #2.
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.
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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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