For Immediate Release
Chicago, IL – May 27, 2020 – Stocks in this week’s article are Donnelley Financial Solutions, Inc. (DFIN - Free Report) , Celestica Inc. (CLS - Free Report) , United States Cellular Corp. (USM - Free Report) , Diamond S Shipping Inc. (DSSI - Free Report) and Heritage Insurance Holdings, Inc. (HRTG - Free Report) .
Tap These 5 Bargain Stocks with Enticing EV/EBITDA Ratios
Investors tend to get fixated on the price-to-earnings (P/E) strategy while seeking stocks that are trading at a bargain. P/E, without a shadow of a doubt, is the most popular multiple used by investors to assess the fair market value of a stock. But even this straightforward, broadly used valuation metric suffers a few downsides.
EV/EBITDA is a Better Approach, Here’s Why
Although the widespread use of P/E stems from its simplicity, a more-complicated metric called EV/EBITDA is sometimes viewed as a better approach as it offers a clearer picture of a company’s valuation and earnings potential. EV/EBITDA, also referred to as the enterprise multiple, determines the total value of a firm while P/E considers only 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 total value of a company.
EBITDA, the other constituent, gives a clearer picture of a company’s profitability as it eliminates 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.
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.
EV/EBITDA takes into account the debt on a company’s balance sheet that P/E ratio does not. 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 assume. Stocks boasting a low EV/EBITDA multiple could be seen as attractive takeover candidates.
Another key drawback of P/E is that it cannot 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 can also 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. It also allows the comparison of companies with different debt levels.
But EV/EBITDA has its limitations too. The ratio varies across industries (a high-growth industry typically has higher multiple and vice versa) and is usually not appropriate while comparing stocks in different industries given their diverse capital requirements.
Hence, instead of just relying on EV/EBITDA, you can club it with the other key ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to achieve the desired outcome.
For the rest of this Screen of the Week article please visit Zacks.com at:https://www.zacks.com/stock/news/944674/tap-these-5-bargain-stocks-with-enticing-evebitda-ratios
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