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Investors generally have a fixation on the price-to-earnings (P/E) multiple while seeking 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 widely popular valuation metric is not without its pitfalls.
EV/EBITDA is a Better Approach, Here’s Why
Although P/E enjoys great popularity among value investors, a less-used and more-complicated metric called EV/EBITDA is sometimes viewed as a better alternative. EV/EBITDA, also referred to as the enterprise multiple, gives the true picture of a company’s valuation and earning potential. It has a more comprehensive approach to valuation.
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.
The other element of the multiple, EBITDA, gives a clearer picture of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that depress net earnings. It is also often used as a proxy for cash flows.
Usually, the lower the EV/EBITDA ratio, the more appealing it is. A low EV/EBITDA ratio could signal that a stock is potentially undervalued.
EV/EBITDA takes into account the debt on a company’s balance sheet that P/E ratio does not. Given 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 key drawback 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. In contrast, EV/EBITDA is less amenable to manipulation and be used to value companies that are making loss but are EBITDA-positive.
EV/EBITDA is also a useful tool 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.
But EV/EBITDA has its downsides too. It varies across industries and is generally not appropriate while comparing stocks in different industries given their diverse capital spending requirements.
Therefore, 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.
Screening Criteria
Here are the parameters to screen for bargain stocks:
EV/EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV/EBITDA ratio represents a cheaper valuation.
P/E using (F1) less than X-Industry Median: This metric screens stocks that are trading at a discount to their peers.
P/B less than X-Industry Median: A lower P/B compared with the industry average implies that the stock is undervalued.
P/S less than X-Industry Median: The lower the P/S ratio the more attractive the stock is as investors will have to pay a smaller price for the same amount of sales generated by the company.
Estimated One-Year EPS Growth F(1)/F(0) greater than or equal to X-Industry Median: This parameter will help in screening stocks that have growth rates higher than the industry median. This is a meaningful indicator as decent earnings growth always adds to investor optimism.
Average 20-day Volume greater than or equal to 100,000: The addition of this metric ensures that shares can be traded easily.
Current Price greater than or equal to $5: This parameter will help in screening stocks that are trading at a minimum price of $5 or higher.
Zacks Rank less than or equal to 2: No screening is complete without the Zacks Rank, which has proven its worth since inception. It is a fundamental truth that stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have always managed to beat adversities and outperform the market.
Value Score of less than or equal to B: Our research shows that stocks with a Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are five of the 15 stocks that passed the screen:
MGM Growth Properties LLC is a real estate investment trust engaged in the acquisition, ownership and leasing of large-scale destination entertainment and leisure resorts. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 6.9% for the current year and a Value Score of B.
AZZ Inc. (AZZ - Free Report) is a global provider of metal coating services, welding solutions, specialty electrical equipment and highly engineered services. This Zacks Rank #2 stock has expected year-over-year earnings growth of 37.2% for the current fiscal year and a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
Donnelley Financial Solutions, Inc. (DFIN - Free Report) is a leader in risk and compliance solutions, offering insightful technology, industry expertise and data insights to clients globally. This Zacks Rank #2 stock has expected year-over-year earnings growth of 6.8% for the current year and a Value Score of A.
Hollysys Automation Technologies Ltd. (HOLI - Free Report) is a leading automation and IT solutions provider that specializes in industrial automation, railway transport automation and mechanical & electrical solutions. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 1.3% for the current fiscal year and a Value Score of A.
Global Net Lease, Inc. (GNL - Free Report) is a real estate investment trust that focuses on acquiring and managing a globally-diversified portfolio of strategically located commercial real estate properties. This Zacks Rank #2 stock has a Value Score of B. The company has an expected year-over-year earnings growth rate of 8.1% for the current year.
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.
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.
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5 Bargain Stocks Boasting Strikingly Low EV/EBITDA Ratios
Investors generally have a fixation on the price-to-earnings (P/E) multiple while seeking 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 widely popular valuation metric is not without its pitfalls.
EV/EBITDA is a Better Approach, Here’s Why
Although P/E enjoys great popularity among value investors, a less-used and more-complicated metric called EV/EBITDA is sometimes viewed as a better alternative. EV/EBITDA, also referred to as the enterprise multiple, gives the true picture of a company’s valuation and earning potential. It has a more comprehensive approach to valuation.
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.
The other element of the multiple, EBITDA, gives a clearer picture of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that depress net earnings. It is also often used as a proxy for cash flows.
Usually, the lower the EV/EBITDA ratio, the more appealing it is. A low EV/EBITDA ratio could signal that a stock is potentially undervalued.
EV/EBITDA takes into account the debt on a company’s balance sheet that P/E ratio does not. Given 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 key drawback 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. In contrast, EV/EBITDA is less amenable to manipulation and be used to value companies that are making loss but are EBITDA-positive.
EV/EBITDA is also a useful tool 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.
But EV/EBITDA has its downsides too. It varies across industries and is generally not appropriate while comparing stocks in different industries given their diverse capital spending requirements.
Therefore, 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.
Screening Criteria
Here are the parameters to screen for bargain stocks:
EV/EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV/EBITDA ratio represents a cheaper valuation.
P/E using (F1) less than X-Industry Median: This metric screens stocks that are trading at a discount to their peers.
P/B less than X-Industry Median: A lower P/B compared with the industry average implies that the stock is undervalued.
P/S less than X-Industry Median: The lower the P/S ratio the more attractive the stock is as investors will have to pay a smaller price for the same amount of sales generated by the company.
Estimated One-Year EPS Growth F(1)/F(0) greater than or equal to X-Industry Median: This parameter will help in screening stocks that have growth rates higher than the industry median. This is a meaningful indicator as decent earnings growth always adds to investor optimism.
Average 20-day Volume greater than or equal to 100,000: The addition of this metric ensures that shares can be traded easily.
Current Price greater than or equal to $5: This parameter will help in screening stocks that are trading at a minimum price of $5 or higher.
Zacks Rank less than or equal to 2: No screening is complete without the Zacks Rank, which has proven its worth since inception. It is a fundamental truth that stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have always managed to beat adversities and outperform the market.
Value Score of less than or equal to B: Our research shows that stocks with a Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are five of the 15 stocks that passed the screen:
MGM Growth Properties LLC is a real estate investment trust engaged in the acquisition, ownership and leasing of large-scale destination entertainment and leisure resorts. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 6.9% for the current year and a Value Score of B.
AZZ Inc. (AZZ - Free Report) is a global provider of metal coating services, welding solutions, specialty electrical equipment and highly engineered services. This Zacks Rank #2 stock has expected year-over-year earnings growth of 37.2% for the current fiscal year and a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
Donnelley Financial Solutions, Inc. (DFIN - Free Report) is a leader in risk and compliance solutions, offering insightful technology, industry expertise and data insights to clients globally. This Zacks Rank #2 stock has expected year-over-year earnings growth of 6.8% for the current year and a Value Score of A.
Hollysys Automation Technologies Ltd. (HOLI - Free Report) is a leading automation and IT solutions provider that specializes in industrial automation, railway transport automation and mechanical & electrical solutions. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 1.3% for the current fiscal year and a Value Score of A.
Global Net Lease, Inc. (GNL - Free Report) is a real estate investment trust that focuses on acquiring and managing a globally-diversified portfolio of strategically located commercial real estate properties. This Zacks Rank #2 stock has a Value Score of B. The company has an expected year-over-year earnings growth rate of 8.1% for the current year.
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.
Click here to sign up for a free trial to the Research Wizard today.
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.