Stocks with low P/E or bargain stocks are always investors’ favorites as the ratio indicates undervaluation. This ratio is obtained by dividing a stock’s current market price with its historical or estimated earnings. It measures how much an investor needs to shell out per dollar of earnings.
So, the golden rule is – the lower the P/E of a stock, the higher its value for investors. This is because value investors believe that a stock's current market price is not reflective of its historical/future earnings and therefore chances of outperformance are higher.
Naturally, there are very few investors who pay attention to stocks with an increasing P/E. But this often-overlooked trend can prove worthwhile in finding great stocks. Let’s dig a little deeper.
Why Rising P/E a Valuable Tool?
Investors should note that stock price moves in tandem with earnings performance. If earnings come in stronger, the price of a stock shoots up. Solid quarterly earnings and the forward guidance boost earnings forecasts, leading to stronger demand for the stock and an uptrend in its price.
So, if the price is rising steadily, it means that investors are assured of the stock’s fundamental strength and expect some strong positives out of it. Suppose an investor wants to buy a stock with a P/E ratio of 30, it means that he is willing to shell out $30 for only $1 worth of earnings. This is because the investor expects earnings of the company to rise at a faster pace in the future on the back of strong fundamentals.
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 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) rating can get through. You can see the complete list of today’s Zacks #1 Rank stocks here.
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 31.
Here are five out of the 31 stocks:
Tuesday Morning Corp. : This is a closeout retailer of upscale home furnishings, gifts and related items in the United States. The stock has a Zacks Rank #1 and comes from a top-ranked Zacks industry (top 5%).
Avinger Inc. (AVGR - Free Report) : This Zacks Rank #2 company, engaged in designing, manufacturing and selling image-guided, catheter-based systems to treat peripheral arterial disease carries a Zacks Rank #2 and belongs to a top-ranked Zacks industry (top 32%).
Skyworks Solutions Inc. (SWKS - Free Report) : This is a Zacks Rank #2 company that designs, manufactures and markets a broad range of high-performance analog and mixed signal semiconductors that enable wireless connectivity. The stock belongs to a top-ranked Zacks industry (top 44%).
SPS Commerce Inc. (SPSC - Free Report) : The Zacks Rank #2 company is a provider of on-demand supply chain management solutions, providing integration, collaboration, connectivity, visibility and data analytics to its customers worldwide. The stock comes from a top-ranked Zacks industry (top 35%).
Varian Medical Systems Inc. (VAR - Free Report) : This is the world’s leading provider of radiotherapy, radiosurgery, proton therapy and brachytherapy for treating cancer and other medical conditions. It has a Zacks Rank #1 and belongs to a top-ranked Zacks industry (top 32%).
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.
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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.