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Image: Bigstock featured highlights include: Genesco, Celestica, Verso, Regal Beloit and Qiwi

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For Immediate Release

Chicago, IL – March 6, 2020 – Stocks in this week’s article are Genesco Inc. GCO, Celestica Inc. CLS, Verso Corp. VRS, Regal Beloit Corp. RBC and Qiwi plc (QIWI - Free Report) .

Tap These 5 Bargain Stocks with Enticing EV/EBITDA Ratios

Investors usually have a fixation with the price-to-earnings (P/E) strategy in their quest for stocks that are trading at a bargain. A widely-favored approach by value investors is to chase stocks that have a low P/E ratio. However, even this straightforward, easy-to-calculate multiple has a few pitfalls.

EV/EBITDA is a Better Approach, But Why?

Although P/E is the most commonly used tool for evaluating a firm’s value, another valuation metric called EV/EBITDA works even better. Also known as the enterprise multiple, this ratio is often viewed as a better alternative to P/E as it offers a clearer picture of a company’s valuation and earnings potential. EV/EBITDA also has a more complete approach to valuation as it determines the total value of a firm as opposed to P/E, which only 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. In a nutshell, it is the entire value of a company.

The other component, EBITDA gives the true picture of a firm’s profitability as it eliminates the impact of non-cash expenses like depreciation and amortization that dilute net earnings.

Just like P/E, the lower the EV/EBITDA ratio, the better it is. A low EV/EBITDA ratio could signal that a stock is potentially undervalued.

Unlike P/E ratio, EV/EBITDA takes debt on a company’s balance sheet into account. Due to this reason, EV/EBITDA is generally used to value potential acquisition targets as it shows the amount of debt the acquirer has to bear. Stocks sporting low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another drawback of P/E is that it can’t be used to value a loss-making company. Moreover, a firm’s earnings are subject to accounting estimates and management manipulation. In contrast, EV/EBITDA is less open to manipulation and can also be used to value companies that are making loss but are EBITDA-positive.

Moreover, EV/EBITDA allows the comparison of companies with different debt levels and is a useful tool in measuring the value of firms that are highly leveraged and have substantial depreciation and amortization expenses.

However, EV/EBITDA is not without its limitations. It varies across industries and is usually not appropriate while comparing stocks in different industries given their diverse capital spending requirements.

Thus, a strategy only based on EV/EBITDA might not fetch the desired outcome. But you can combine it with other major ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen bargain stocks.

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