For Immediate Release
Chicago, IL – August 8, 2019 - Stocks in this week’s article are DaVita Inc. (DVA - Free Report) , Kraton Corporation (KRA - Free Report) , ADT Inc. (ADT - Free Report) , Universal Forest Products, Inc. (UFPI - Free Report) and International Game Technology PLC (IGT - Free Report) .
5 Value Picks Boasting Strikingly Low EV/EBITDA Ratios
The price-to-earnings (P/E) ratio, given its apparent simplicity, is preferred by many investors while uncovering stocks that are trading at attractive prices. A widely favored approach by value investors is to chase stocks that have a low P/E ratio. However, even this widely popular valuation metric is not without its pitfalls.
Is EV/EBITDA a Better Alternative to P/E?
While P/E enjoys huge popularity in the value investing world, a more complicated valuation metric called EV/EBITDA works even better. The ratio offers a clearer picture of a firm’s valuation and earnings potential. EV/EBITDA, also referred to as enterprise multiple, determines the total value of a firm, while P/E just considers its equity portion.
EV/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. Simply put, it is the total value of a company.
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 reduce net earnings. It is also often used as a proxy for cash flows.
Just like P/E, the lower the EV/EBITDA ratio, the more appealing it is. A low EV/EBITDA ratio could be a sign that a stock is potentially undervalued.
However, unlike P/E ratio, EV/EBITDA takes into account the debt on a company’s balance sheet. For this reason, EV/EBITDA is usually used to value possible acquisition targets. Stocks with a low EV/EBITDA multiple could be seen as potential takeover candidates.
Another limitation of P/E is that it can’t be used to value a loss-making entity. A firm’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV/EBITDA is difficult to manipulate and also can be used to value entities that have negative net earnings but are positive on the EBITDA front.
EV/EBITDA is also a useful yardstick 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.
Then again, EV/EBITDA has its flaws too. It varies across industries (a high-growth industry normally has higher multiple and vice versa) and is typically not appropriate while comparing stocks in different industries given their diverse capital expenditure requirements.
Thus, instead of just relying 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 achieve the desired results.
For the rest of this Screen of the Week article please visit Zacks.com at: https://www.zacks.com/stock/news/460335/5-value-picks-boasting-strikingly-low-evebitda-ratios?art_rec=quote-stock_overview-zacks_news-ID02-txt-460335
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