One of the most common forms of investing techniques is running after stocks with a low price-to-earnings (P/E) ratio. That’s because this basic measure of how much investors are spending for $1 worth of earnings speaks of undervaluation. The logic is simple — a stock’s current market price does not justify its higher earnings and therefore leaves room for upside.
But have you ever given it a thought that stocks with a rising P/E can also be worth buying. We’ll tell you why.
How Does Increasing P/E Theory Work?
The concept is that as earnings rise, the price of a stock goes up. As forecasts for expected earnings come in higher, strong demand for the stock should continue to push up its prices.
A stock's P/E gives an indication of how much investors are ready to shell out per dollar of earnings. So, if the P/E of a stock is rising steadily, it means that investors are assured of its inherent strength and believe that more positives are to come out of it.
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 time frames.)
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 factors narrowed down the universe from over 7,700 stocks to just 42.
Here are five of 42 stocks that passed the screen:
Avinger Inc. (AVGR - Free Report) : This company is engaged in designing, manufacturing and selling image-guided, catheter-based systems to treat peripheral arterial disease. It belongs to a top-ranked Zacks industry (top 23%) and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
TripAdvisor Inc. (TRIP - Free Report) : This #2 Ranked company is one of the largest online travel research companies in the world. It comes from a top-ranked Zacks industry (top 17%).
Alexion Pharmaceuticals Inc. (ALXN - Free Report) : This is a biopharmaceutical company focused on the development and commercialization of life-transforming drugs for the treatment of patients with ultra-rare disorders. The company belongs to a top-ranked Zacks industry (top 27%) and carries a Zacks Rank #2.
Check Point Software Technologies Ltd. (CHKP - Free Report) : This provider of information technology security solutions across the world comes from a top-ranked Zacks industry (top 33%). It carries a Zacks Rank #2.
ServiceNow Inc. (NOW - Free Report) : This company provides cloud computing services that automate digital workflows to accelerate enterprise IT operations. The Zacks Rank #2 stock hails from 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.
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.