Investors always look for stocks with low P/E ratios as the measure indicates undervaluation. This ratio is obtained by dividing a stock’s current market price with its historical or estimated earnings. It delivers how much an investor needs to shell out per dollar of earnings.
In fact, the golden rule is – the lower the P/E of a stock, the higher will be 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.
But there is another side to the story that points to stocks with an increasing P/E. But this often-overlooked trend can prove pivotal in finding great stocks. Let’s dig a little deeper.
How Can Rising P/E Be Helpful?
Investors should note that stock prices move in tandem with earnings performance. Ifearnings come in stronger, the price of a stock soars. Solid quarterly earnings and guidance in turn boost the earnings forecast, 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, expect some strong positives out of it as well as solid and faster earnings growth. Moreover, 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 38.
Here are five out of the 38 stocks:
JAKKS Pacific Inc (JAKK - Free Report) ): JAKKS Pacific is a multi-brand company that has been designing and marketing a broad range of toys and consumer products since 1995. The stock has a Zacks Rank #1. Itcomes from a favorable Zacks industry (placed at the top 6% of total 250+ industries in the Zacks universe).
Avinger Inc (AVGR - Free Report) : The Zacks Rank #2 company is engaged in designing, manufacturing and selling image-guided, catheter-based systems to treat peripheral arterial disease. Itcomes from a favorable Zacks industry(top 14%).
Energous Corporation (WATT - Free Report) ): The Zacks Rank #2 company is a developer of a disruptive wire-free charging technology.
FireEye Inc (FEYE - Free Report) : This Zacks Rank #2 company is a specialized provider of a security platform against cyber-attacks to enterprises and governments. It belongs to a favorable Zacks industry(top 21%).
Proteostasis Therapeutics Inc (PTI - Free Report) : The Zacks Rank #2 company is a biopharmaceutical company which focuses on the discovery and development of novel therapeutics to treat diseases caused by an imbalance in the proteostasis network primarily in the United States. It belongs to a favorable Zacks industry(top 21%).
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.