Price-to-earnings (P/E), given its inherent simplicity, is the most commonly used metric in the value investing world. It is preferred by many investors while handpicking stocks trading at attractive prices. However, even this straightforward, broadly used valuation metric has a few limitations.
Although P/E enjoys great popularity among value investors, a less-used and more-complicated metric called EV-to-EBITDA is sometimes viewed as a better alternative. EV-to-EBITDA gives the true picture of a company’s valuation and earnings potential. It has a more comprehensive approach to valuation.
United Natural Foods, Inc.
UNFI
,
TD SYNNEX Corporation
SNX
,
The Container Store Group, Inc.
TCS
,
UGI Corporation
UGI
and
ArcBest Corporation
ARCB
are some stocks with attractive EV-to-EBITDA ratios.
What Makes EV-to-EBITDA a Better Alternative?
EV-to-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 component of the multiple, EBITDA, gives a better idea of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows.
Usually, the lower the EV-to-EBITDA ratio, the more attractive it is. A low EV-to-EBITDA ratio could signal that a stock is potentially undervalued.
However, unlike the P/E ratio, EV-to-EBITDA takes into account the debt on a company’s balance sheet. Given this reason, EV-to-EBITDA is usually used to value the possible acquisition targets. Stocks with a low EV-to-EBITDA multiple could be seen as potential takeover candidates.
Moreover, P/E can’t be used to value a loss-making firm. A firm’s earnings are also subject to accounting estimates and management manipulation. In contrast, EV-to-EBITDA is harder to manipulate and can also be used to value companies that have negative net earnings but are positive on the EBITDA front.
EV-to-EBITDA is also a useful yardstick in evaluating 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-to-EBITDA has its limitations too. The ratio varies across industries (a high-growth industry typically has a higher multiple and vice versa) and is usually not appropriate while comparing stocks in different industries given their diverse capital requirements.
Therefore, instead of just relying on EV-to-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 value stocks:
EV-to-EBITDA 12 Months-Most Recent less than X-Industry Median:
A lower EV-to-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 13 stocks that passed the screen:
United Natural Foods
is a leading distributor of natural, organic and specialty food and non-food products in the United States and Canada. This Zacks Rank #1 stock has a Value Score of A.
United Natural Foods has an expected year-over-year earnings growth rate of 8.8% for the current fiscal year. The Zacks Consensus Estimate for UNFI’s current fiscal year earnings has been revised 3.4% upward over the last 60 days.
TD SYNNEX
is a leading business process services company. This Zacks Rank #1 stock has a Value Score of B. You can see
the complete list of today’s Zacks #1 Rank stocks here
.
TD SYNNEX has an expected year-over-year earnings growth rate of 17.7% for the current fiscal year. The Zacks Consensus Estimate for SNX’s current fiscal year earnings has been revised 7.6% upward over the last 60 days.
The Container Store Group
is a leading specialty retailer of storage and organization products and solutions, and custom closets. This Zacks Rank #2 stock has a Value Score of A.
The Container Store Group has an expected year-over-year earnings growth rate of 25% for the current fiscal year. TCS beat the Zacks Consensus Estimate for earnings in each of the trailing four quarters, the average being 101.5%.
UGI
distributes, stores, transports and markets energy products and related services. This Zacks Rank #2 stock has a Value Score of A.
UGI has an expected year-over-year earnings growth rate of 9.8% for the current fiscal year. It beat the Zacks Consensus Estimate for earnings in three of the last four quarters. UGI has a trailing four-quarter earnings surprise of roughly 2.4%, on average.
ArcBest
provides freight transportation services and solutions. This Zacks Rank #2 stock has a Value Score of A.
ArcBest has expected year-over-year earnings growth of 17.3% for the current year. The consensus estimate for ARCB’s current-year earnings has been revised 3.5% upward over the last 60 days.
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
.
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