Back to top featured highlights include: ArcBest, Santander, Rayonier, Atlas Air and UGI

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For Immediate Release

Chicago, IL – August 31, 2018 - Stocks in this week’s article are ArcBest Corp. (ARCB - Free Report) , Santander Consumer USA Holdings Inc. (SC - Free Report) , Rayonier Advanced Materials Inc. (RYAM - Free Report) , Atlas Air Worldwide Holdings, Inc. (AAWW - Free Report) and UGI Corporation (UGI - Free Report) .

Top 5 Value Stocks Flaunting Alluring EV/EBITDA Ratios

The price-to-earnings (P/E) ratio is the most-preferred among valuation metrics in the investment toolkit for evaluating the fair market value of a stock. Many prefer to take the P/E route in their pursuit for stocks that are trading at attractive prices. However, even this widely-popular equity valuation multiple suffers a few drawbacks.

Why EV/EBITDA is a Better Option?

Although P/E is the most commonly used tool for assessing a firm’s value, another valuation metric called EV/EBITDA does a better job. The ratio offers a clearer picture of a firm’s valuation and earnings potential. EV/EBITDA, also referred to as the enterprise multiple, determines the total value of a firm, while P/E just considers its equity portion.  

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.

EBITDA, the other constituent, is a true reflection of a company’s profitability as it strips out non-cash expenses like depreciation and amortization that dilute net earnings. It is also often used as a proxy for cash flows.

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

EV/EBITDA takes debt on a company’s balance sheet into account that P/E does not. Due to this reason, EV/EBITDA is typically used to value possible acquisition targets, as it shows the amount of debt the acquirer has to assume. Companies with a low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another major limitation 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. In comparison, EV/EBITDA is less amenable to manipulation and can also be used to value firms that have negative net earnings but are positive on the EBITDA front.

EV/EBITDA is also a useful yardstick in measuring the value of companies that are highly leveraged and have a high degree of depreciation. Moreover, the ratio allows the comparison of companies with different debt levels.

However, EV/EBITDA is also not without its downsides and alone can’t 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 solely banking on EV/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 screen true value stocks.

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