For Immediate Release
Chicago, IL – February 5, 2020 - Stocks in this week’s article Genesco Inc. (GCO - Free Report) , Celestica Inc. (CLS - Free Report) , OFG Bancorp (OFG - Free Report) and AdvanSix Inc. (ASIX - Free Report) .
Pick These 5 Bargain Stocks with Alluring EV/EBITDA Ratios
The price-to-earnings (P/E) ratio is broadly considered by investors as a yardstick for evaluating the fair market value of a stock. Many value investors prefer to take the P/E route in their quest for stocks that are trading at bargain prices. However, even this ubiquitously used equity valuation multiple is not devoid of limitations.
Is EV/EBITDA a Better Alternative to P/E?
While P/E enjoys significant popularity in the value investing world, a more complicated metric called EV/EBITDA gains an upper hand as it offers a clearer image 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 considers just 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 of the ratio, 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 enticing it is. A low EV/EBITDA ratio could signal 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 downside of P/E is that it can’t be used to value a loss-making company. A company’s earnings are also subject to accounting estimates and management manipulation. EV/EBITDA, in contrast, is less amenable to manipulation and can be used to value firms that have negative net earnings but are positive on the EBITDA side.
EV/EBITDA is also a useful tool in assessing the value of firms 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 shortcomings and alone cannot 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 just banking on EV/EBITDA, you can combine it with the other major ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen bargain stocks.
For the rest of this Screen of the Week article please visit Zacks.com at: https://www.zacks.com/stock/news/748350/pick-these-5-bargain-stocks-with-alluring-evebitda-ratios
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